Yahoo Finance Here's Why South32 (ASX:S32) Can Manage Its Debt Responsibly
Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We can see that South32 Limited (ASX:S32) does use debt in its business. But the more important question is: how much risk is that debt creating?
When Is Debt A Problem?
Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.
Check out our latest analysis for South32
What Is South32's Net Debt?
As you can see below, South32 had US$366.0m of debt, at June 2020, which is about the same as the year before. You can click the chart for greater detail. But on the other hand it also has US$1.32b in cash, leading to a US$949.0m net cash position.
How Healthy Is South32's Balance Sheet?
The latest balance sheet data shows that South32 had liabilities of US$1.27b due within a year, and liabilities of US$2.90b falling due after that. Offsetting these obligations, it had cash of US$1.32b as well as receivables valued at US$558.0m due within 12 months. So it has liabilities totalling US$2.30b more than its cash and near-term receivables, combined.
South32 has a market capitalization of US$7.89b, so it could very likely raise cash to ameliorate 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. While it does have liabilities worth noting, South32 also has more cash than debt, so we're pretty confident it can manage its debt safely.
Shareholders should be aware that South32's EBIT was down 91% last year. If that earnings trend continues then paying off its debt will be about as easy as herding cats on to a roller coaster. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if South32 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.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While South32 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. Happily for any shareholders, South32 actually produced more free cash flow than EBIT over the last three years. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.
Summing up
While South32 does have more liabilities than liquid assets, it also has net cash of US$949.0m. The cherry on top was that in converted 130% of that EBIT to free cash flow, bringing in US$592m. So we are not troubled with South32's debt use. While South32 didn't make a statutory profit in the last year, its positive EBIT suggests that profitability might not be far away. Click here to see if its earnings are heading in the right direction, over the medium term.
If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.
This article by Simply Wall St is general in nature. 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.
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