Is Anglo American Platinum (JSE:AMS) Using Too Much Debt?

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 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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.

Check out 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 Anglo American Platinum had R82.0m of debt in December 2022, down from R131.0m, one year before. But on the other hand it also has R33.5b in cash, leading to a R33.5b net cash position.

How Healthy Is Anglo American Platinum's Balance Sheet?

The latest balance sheet data shows that Anglo American Platinum had liabilities of R58.1b due within a year, and liabilities of R21.9b falling due after that. Offsetting these obligations, it had cash of R33.5b as well as receivables valued at R4.03b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by R42.4b.

Since publicly traded Anglo American Platinum shares are worth a very impressive total of R289.9b, it seems unlikely that this level of liabilities would be a major threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. 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 34% cut to EBIT over the last year. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Anglo American Platinum's ability to maintain a healthy balance sheet going forward. 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 R33.5b. So we don't have any problem with Anglo American Platinum's use of debt. 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. These risks can be hard to spot. Every company has them, and we've spotted 3 warning signs for Anglo American Platinum (of which 2 are a bit unpleasant!) 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.