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Warren Buffett famously said, 'Volatility is far from synonymous with risk.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We note that AMG Advanced Metallurgical Group N.V. (AMS:AMG) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?
When Is Debt A Problem?
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. 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. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.
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What Is AMG Advanced Metallurgical Group's Net Debt?
The chart below, which you can click on for greater detail, shows that AMG Advanced Metallurgical Group had US$380.4m in debt in June 2019; about the same as the year before. However, it also had US$271.7m in cash, and so its net debt is US$108.7m.
How Healthy Is AMG Advanced Metallurgical Group's Balance Sheet?
We can see from the most recent balance sheet that AMG Advanced Metallurgical Group had liabilities of US$380.2m falling due within a year, and liabilities of US$595.8m due beyond that. Offsetting these obligations, it had cash of US$271.7m as well as receivables valued at US$160.4m due within 12 months. So it has liabilities totalling US$543.9m more than its cash and near-term receivables, combined.
This deficit is considerable relative to its market capitalization of US$772.6m, so it does suggest shareholders should keep an eye on AMG Advanced Metallurgical Group's use of debt. This suggests shareholders would heavily diluted if the company needed to shore up its balance sheet in a hurry.
In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).