Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that ‘Volatility is far from synonymous with risk.’ 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 ArcelorMittal South Africa Ltd (JSE:ACL) does use debt in its business. But is this debt a concern to shareholders?
When Is Debt Dangerous?
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. Ultimately, if the company can’t fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
How Much Debt Does ArcelorMittal South Africa Carry?
You can click the graphic below for the historical numbers, but it shows that as of December 2020 ArcelorMittal South Africa had R7.18b of debt, an increase on R5.36b, over one year. However, it does have R3.34b in cash offsetting this, leading to net debt of about R3.84b.
How Healthy Is ArcelorMittal South Africa’s Balance Sheet?
We can see from the most recent balance sheet that ArcelorMittal South Africa had liabilities of R12.8b falling due within a year, and liabilities of R6.89b due beyond that. Offsetting this, it had R3.34b in cash and R1.62b in receivables that were due within 12 months. So it has liabilities totalling R14.7b more than its cash and near-term receivables, combined.
This deficit casts a shadow over the R3.47b company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. After all, ArcelorMittal South Africa would likely require a major re-capitalisation if it had to pay its creditors today. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine ArcelorMittal South Africa’s ability to maintain a healthy balance sheet going forward. So if you’re focused on the future you can check out this free report showing analyst profit forecasts.
In the last year ArcelorMittal South Africa had a loss before interest and tax, and actually shrunk its revenue by 40%, to R25b. To be frank that doesn’t bode well.
Not only did ArcelorMittal South Africa’s revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). Its EBIT loss was a whopping R924m. If you consider the significant liabilities mentioned above, we are extremely wary of this investment. That said, it is possible that the company will turn its fortunes around. But we think that is unlikely since it is low on liquid assets, and made a loss of R1.9b in the last year. So while it’s not wise to assume the company will fail, we do think it’s risky. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet – far from it. For example – ArcelorMittal South Africa has 1 warning sign we think you should be aware of.
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.
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