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

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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. As with many other companies Anglo American Platinum Limited (JSE:AMS) makes use of debt. 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. 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. 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 Debt?

The image below, which you can click on for greater detail, shows that at June 2024 Anglo American Platinum had debt of R10.9b, up from R7.30b in one year. But on the other hand it also has R26.9b in cash, leading to a R16.0b net cash position.

How Strong Is Anglo American Platinum's Balance Sheet?

The latest balance sheet data shows that Anglo American Platinum had liabilities of R51.6b due within a year, and liabilities of R23.8b falling due after that. Offsetting this, it had R26.9b in cash and R6.82b in receivables that were due within 12 months. So its liabilities total R41.8b more than the combination of its cash and short-term receivables.

This deficit isn't so bad because Anglo American Platinum is worth R157.3b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution. 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 50% in the last twelve months. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. There's no doubt that we learn most about debt from the balance sheet. 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 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. Looking at the most recent three years, Anglo American Platinum recorded free cash flow of 41% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing Up

While Anglo American Platinum does have more liabilities than liquid assets, it also has net cash of R16.0b. So we don't have any problem with Anglo American Platinum's use of debt. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. For example - Anglo American Platinum has 1 warning sign we think you should be aware of.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.