These 4 Measures Indicate That Anglo American Platinum (JSE:AMS) Is Using Debt Safely

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says '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. Importantly, Anglo American Platinum Limited (JSE:AMS) does carry debt. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Anglo American Platinum

How Much Debt Does Anglo American Platinum Carry?

You can click the graphic below for the historical numbers, but it shows that Anglo American Platinum had R131.0m of debt in December 2021, down from R256.0m, one year before. However, its balance sheet shows it holds R51.5b in cash, so it actually has R51.4b net cash.

A Look At Anglo American Platinum's Liabilities

According to the last reported balance sheet, Anglo American Platinum had liabilities of R56.5b due within 12 months, and liabilities of R21.3b due beyond 12 months. On the other hand, it had cash of R51.5b and R4.96b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by R21.4b.

Since publicly traded Anglo American Platinum shares are worth a very impressive total of R549.6b, 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.

Better yet, Anglo American Platinum grew its EBIT by 171% last year, which is an impressive improvement. If maintained that growth will make the debt even more manageable in the years ahead. 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 want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. 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. During the last three years, Anglo American Platinum produced sturdy free cash flow equating to 70% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Summing up

We could understand if investors are concerned about Anglo American Platinum's liabilities, but we can be reassured by the fact it has has net cash of R51.4b. And we liked the look of last year's 171% year-on-year EBIT growth. So we don't think Anglo American Platinum's use of debt is risky. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should learn about the 2 warning signs we've spotted with Anglo American Platinum (including 1 which is potentially serious) .

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.