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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. Importantly, Peabody Energy Corporation (NYSE:BTU) does carry debt. But should shareholders be worried about its use of debt?
Why Does Debt Bring Risk?
Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. If things get really bad, the lenders can take control of the business. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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.
How Much Debt Does Peabody Energy Carry?
The chart below, which you can click on for greater detail, shows that Peabody Energy had US$313.4m in debt in September 2024; about the same as the year before. However, its balance sheet shows it holds US$772.9m in cash, so it actually has US$459.5m net cash.
A Look At Peabody Energy's Liabilities
According to the last reported balance sheet, Peabody Energy had liabilities of US$778.6m due within 12 months, and liabilities of US$1.40b due beyond 12 months. Offsetting these obligations, it had cash of US$772.9m as well as receivables valued at US$304.2m due within 12 months. So its liabilities total US$1.10b more than the combination of its cash and short-term receivables.
Peabody Energy has a market capitalization of US$2.46b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. While it does have liabilities worth noting, Peabody Energy also has more cash than debt, so we're pretty confident it can manage its debt safely.
The modesty of its debt load may become crucial for Peabody Energy if management cannot prevent a repeat of the 59% cut to EBIT over the last year. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. 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 Peabody Energy'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.
Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Peabody Energy 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. Over the most recent three years, Peabody Energy recorded free cash flow worth 71% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.
Summing Up
While Peabody Energy does have more liabilities than liquid assets, it also has net cash of US$459.5m. The cherry on top was that in converted 71% of that EBIT to free cash flow, bringing in US$346m. So we are not troubled with Peabody Energy's debt use. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 5 warning signs for Peabody Energy (1 shouldn't be ignored!) that you should be aware of before investing here.
At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.
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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.
