David Iben said it well when he said: “Volatility is not a risk that interests us. What matters to us is to avoid the permanent loss of capital. It’s natural to consider a company’s balance sheet when looking at its riskiness, as debt is often involved when a company fails. We can see that Holcim Ltd (VTX:HOLN) uses debt in its business. But should shareholders worry about its use of debt?
What risk does debt carry?
Generally speaking, debt only becomes a real problem when a company cannot easily repay it, either by raising capital or with its own 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 costly) event is when a company has to issue shares at bargain prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, many companies use debt to finance their growth, without any negative consequences. When we think about a company’s use of debt, we first look at cash and debt together.
Check out our latest analysis for Holcim
What is Holcim’s net debt?
The image below, which you can click on for more details, shows that in June 2022, Holcim had a debt of CHF 16.9 billion, compared to CHF 14.6 billion in one year. However, he has 4.40 billion francs in cash to offset this, resulting in a net debt of around 12.5 billion francs.
How healthy is Holcim’s balance sheet?
Zooming in on the latest balance sheet data, we can see that Holcim had liabilities of CHF 11.6 billion maturing within 12 months and liabilities of CHF 20.7 billion maturing beyond. In compensation for these obligations, it had cash of 4.40 billion francs as well as receivables valued at 4.73 billion francs due within 12 months. Thus, its liabilities total 23.1 billion francs more than the combination of its cash and short-term receivables.
This deficit is considerable compared to its very large market capitalization of CHF 27.7 billion, so he suggests that shareholders monitor Holcim’s use of debt. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet quickly.
In order to assess a company’s debt relative to its earnings, we calculate its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and its earnings before interest and taxes (EBIT) divided by its expenses. interest (its interest coverage). In this way, we consider both the absolute amount of debt, as well as the interest rates paid on it.
Holcim’s net debt to EBITDA ratio of around 2.1 suggests only moderate reliance on debt. And its towering EBIT of 13.4 times its interest expense means that the debt burden is as light as a peacock feather. If Holcim can continue to grow EBIT at last year’s rate of 16% over last year, then it will find its debt more manageable. The balance sheet is clearly the area to focus on when analyzing debt. But ultimately, the company’s future profitability will decide whether Holcim can strengthen its balance sheet over time. So if you are focused on the future, you can check out this free report showing analyst earnings forecast.
Finally, a business needs free cash flow to pay off its debts; book profits are not enough. We must therefore clearly examine whether this EBIT generates a corresponding free cash flow. Over the past three years, Holcim has recorded free cash flow of 97% of its EBIT, which is higher than what we would normally expect. This positions him well to pay off debt if desired.
Our point of view
The good news is that Holcim’s demonstrated ability to cover its interest charges with its EBIT delights us like a fluffy puppy does a toddler. But, on a darker note, we’re a bit concerned about his total passive level. All in all, it looks like Holcim can comfortably manage its current level of debt. On the plus side, this leverage can increase shareholder returns, but the potential downside is more risk of loss, so it’s worth keeping an eye on the balance sheet. The balance sheet is clearly the area to focus on when analyzing debt. However, not all investment risks reside on the balance sheet, far from it. We have identified 1 warning sign with Holcim and understanding them should be part of your investment process.
If you are interested in investing in companies that can generate profits without the burden of debt, then check out this free list of growing companies that have net cash on the balance sheet.
Feedback on this article? Concerned about content? Get in touch with us directly. You can also email the editorial team (at) Simplywallst.com.
This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.