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

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. Importantly, Anglo American Platinum Limited (JSE:AMS) does carry debt. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Anglo American Platinum

What Is Anglo American Platinum's Debt?

You can click the graphic below for the historical numbers, but it shows that as of June 2023 Anglo American Platinum had R7.30b of debt, an increase on R106.0m, over one year. However, it does have R33.4b in cash offsetting this, leading to net cash of R26.1b.

How Healthy Is Anglo American Platinum's Balance Sheet?

We can see from the most recent balance sheet that Anglo American Platinum had liabilities of R56.7b falling due within a year, and liabilities of R21.9b due beyond that. 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 very large market capitalization of R202.7b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. While it does have liabilities worth noting, Anglo American Platinum also has more cash than debt, so we're pretty confident it can manage its debt safely.

The modesty of its debt load may become crucial for Anglo American Platinum if management cannot prevent a repeat of the 55% cut to EBIT over the last year. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Anglo American Platinum can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. While Anglo American Platinum has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. 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 cold hard cash means it can reduce its debt when it wants to.

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 are not troubled with Anglo American Platinum's debt use. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. We've identified 3 warning signs with Anglo American Platinum (at least 1 which is a bit unpleasant) , and understanding them should be part of your investment process.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.