Sappi (JSE:SAP) Has Debt But No Earnings; Should You Worry?

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. We note that Sappi Limited (JSE:SAP) does have debt on its balance sheet. But is this debt a concern to shareholders?

When Is Debt A Problem?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. If things get really bad, the lenders can take control of the business. 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.

See our latest analysis for Sappi

What Is Sappi's Debt?

The chart below, which you can click on for greater detail, shows that Sappi had US$1.61b in debt in June 2024; about the same as the year before. On the flip side, it has US$365.0m in cash leading to net debt of about US$1.25b.

A Look At Sappi's Liabilities

We can see from the most recent balance sheet that Sappi had liabilities of US$1.23b falling due within a year, and liabilities of US$2.21b due beyond that. Offsetting this, it had US$365.0m in cash and US$685.0m in receivables that were due within 12 months. So its liabilities total US$2.39b more than the combination of its cash and short-term receivables.

Given this deficit is actually higher than the company's market capitalization of US$1.61b, we think shareholders really should watch Sappi's debt levels, like a parent watching their child ride a bike for the first time. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Sappi 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.

Over 12 months, Sappi made a loss at the EBIT level, and saw its revenue drop to US$5.4b, which is a fall of 15%. That's not what we would hope to see.

Caveat Emptor

Not only did Sappi's revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). To be specific the EBIT loss came in at US$85m. When we look at that alongside the significant liabilities, we're not particularly confident about the company. We'd want to see some strong near-term improvements before getting too interested in the stock. Not least because it burned through US$177m in negative free cash flow over the last year. That means it's on the risky side of things. 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. Be aware that Sappi is showing 3 warning signs in our investment analysis , and 2 of those are significant...

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.