David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' 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 note that Warrior Met Coal, Inc. (NYSE:HCC) does have debt on its balance sheet. But should shareholders be worried about its use of debt?
What Risk Does Debt Bring?
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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
What Is Warrior Met Coal's Net Debt?
You can click the graphic below for the historical numbers, but it shows that Warrior Met Coal had US$153.0m of debt in December 2023, down from US$302.6m, one year before. But on the other hand it also has US$747.2m in cash, leading to a US$594.2m net cash position.
How Strong Is Warrior Met Coal's Balance Sheet?
We can see from the most recent balance sheet that Warrior Met Coal had liabilities of US$147.7m falling due within a year, and liabilities of US$334.9m due beyond that. Offsetting these obligations, it had cash of US$747.2m as well as receivables valued at US$110.4m due within 12 months. So it can boast US$375.1m more liquid assets than total liabilities.
This surplus suggests that Warrior Met Coal has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Warrior Met Coal has more cash than debt is arguably a good indication that it can manage its debt safely.
The modesty of its debt load may become crucial for Warrior Met Coal if management cannot prevent a repeat of the 33% 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. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Warrior Met Coal can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.
Finally, a company can only pay off debt with cold hard cash, not accounting profits. While Warrior Met Coal 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. During the last three years, Warrior Met Coal produced sturdy free cash flow equating to 69% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.
Summing Up
While it is always sensible to investigate a company's debt, in this case Warrior Met Coal has US$594.2m in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of US$209m, being 69% of its EBIT. So we are not troubled with Warrior Met Coal's debt use. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 2 warning signs for Warrior Met Coal that 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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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.