David Iben put it well when he said, “Volatility is not a risk we care about. What matters to us is to avoid the permanent loss of capital. ‘ So it can be obvious that you need to consider debt, when you think about how risky a given stock is, because too much debt can sink a business. We can see that Outokumpu Oyj (HEL: OUT1V) uses debt in his business. But should shareholders be concerned about its use of debt?
What risk does debt entail?
Debt helps a business until the business struggles to repay it, either with new capital or with free cash flow. Ultimately, if the company cannot meet its legal debt repayment obligations, shareholders could walk away with nothing. However, a more common (but still painful) scenario is that he must raise new equity at low cost, thereby diluting shareholders over the long term. That said, the most common situation is where a business manages its debt reasonably well – and to its own advantage. The first step in examining a company’s debt levels is to consider its cash flow and debt together.
Check out our latest analysis for Outokumpu Oyj
What is Outokumpu Oyj’s net debt?
As you can see below, Outokumpu Oyj had € 1.15 billion in debt in June 2021, up from € 1.64 billion the year before. However, because it has a cash reserve of € 316.0 million, its net debt is lower, at around € 838.0 million.
How healthy is Outokumpu Oyj’s track record?
Zooming in on the latest balance sheet data, we can see that Outokumpu Oyj had a liability of € 2.01 billion due within 12 months and a liability of € 1.37 billion due beyond. On the other hand, it had cash of € 316.0 million and € 822.0 million in receivables within one year. Its liabilities therefore amount to € 2.24 billion more than the combination of its cash and short-term receivables.
This deficit is sizable compared to his market capitalization of 2.49 billion euros, so he suggests shareholders keep an eye on Outokumpu Oyj’s use of debt. This suggests that shareholders would be heavily diluted if the company needed to consolidate its balance sheet quickly.
We measure a company’s debt load relative to its earning capacity by looking at its net debt divided by its earnings before interest, taxes, depreciation, and amortization (EBITDA) and calculating how easily its earnings before interest and taxes (EBIT) covers its interest costs (interest coverage). In this way, we consider both the absolute amount of debt, as well as the interest rates paid on it.
Outokumpu Oyj’s net debt stands at a very reasonable level of 2.1 times its EBITDA, while its EBIT only covered its interest expense 2.9 times last year. It appears the company incurs significant depreciation and amortization costs, so perhaps its debt load is heavier than it first appears, since EBITDA is arguably a generous measure of profits. We also note that Outokumpu Oyj improved its EBIT from a loss of last year to a positive amount of 200 million euros. There is no doubt that we learn the most about debt from the balance sheet. But it is future profits, more than anything, that will determine Outokumpu Oyj’s ability to maintain a healthy balance sheet in the future. So if you are focused on the future you can check this out free report showing analysts’ earnings forecasts.
Finally, a business can only pay off its debts with hard cash, not with book profits. It is therefore worth checking to what extent earnings before interest and taxes (EBIT) are backed by free cash flow. Over the past year, Outokumpu Oyj generated free cash flow of 88% of its very robust EBIT, more than we expected. This puts him in a very strong position to pay off the debt.
Our point of view
Outokumpu Oyj’s interest coverage and total liability level certainly weighs on it, in our view. But the good news is that it seems to be able to easily convert EBIT into free cash flow. We think Outokumpu Oyj’s debt makes it a bit risky, having looked at the aforementioned data points together. This isn’t necessarily a bad thing, as leverage can increase returns on equity, but it’s something to be aware of. The balance sheet is clearly the area you need to focus on when analyzing debt. However, not all investment risks lie on the balance sheet – far from it. Example: we have spotted 3 warning signs for Outokumpu Oyj you need to be aware, and 2 of them are important.
Of course, if you are the type of investor who prefers to buy stocks without going into debt, feel free to check out our exclusive list of cash net growth stocks today.
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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts using only unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell shares and does not take into account your goals or your financial situation. Our aim is to bring you long-term, targeted analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price sensitive companies or qualitative material. Simply Wall St has no position in the mentioned stocks.
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