Here's Why Anglo American Platinum (JSE:AMS) Can Manage Its Debt Responsibly

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We note that Anglo American Platinum Limited (JSE:AMS) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Anglo American Platinum

What Is Anglo American Platinum's Net Debt?

The image below, which you can click on for greater detail, shows that at June 2023 Anglo American Platinum had debt of R7.30b, up from R106.0m in one year. However, its balance sheet shows it holds R33.4b in cash, so it actually has R26.1b net cash.

How Healthy Is Anglo American Platinum's Balance Sheet?

According to the last reported balance sheet, Anglo American Platinum had liabilities of R56.7b due within 12 months, and liabilities of R21.9b due beyond 12 months. On the other hand, it had cash of R33.4b and R3.66b worth of receivables due within a year. So it has liabilities totalling R41.5b more than its cash and near-term receivables, combined.

Anglo American Platinum has a market capitalization of R163.2b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt. Despite its noteworthy liabilities, Anglo American Platinum boasts net cash, so it's fair to say it does not have a heavy debt load!

In fact Anglo American Platinum's saving grace is its low debt levels, because its EBIT has tanked 55% in the last twelve months. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Anglo American Platinum can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. Anglo American Platinum may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Over the most recent three years, Anglo American Platinum recorded free cash flow worth 60% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing Up

Although Anglo American Platinum's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of R26.1b. So we don't have any problem with Anglo American Platinum's use of debt. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for Anglo American Platinum (of which 1 is a bit concerning!) you should know about.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.