Outokumpu Oyj (HEL:OUT1V) has a fairly healthy balance sheet

Warren Buffett said: “Volatility is far from synonymous with risk. So it seems smart money knows that debt – which is usually involved in bankruptcies – is a very important factor when you’re assessing a company’s risk. Like many other companies Outokumpu Oyj (HEL:OUT1V) uses debt. But the more important question is: what risk does this debt create?

What risk does debt carry?

Debt helps a business until the business struggles to pay it back, either with new capital or with free cash flow. An integral part of capitalism is the process of “creative destruction” where bankrupt companies are mercilessly liquidated by their bankers. However, a more frequent (but still costly) event is when a company has to issue shares at bargain prices, permanently diluting shareholders, just to shore up its balance sheet. That said, the most common situation is when a company manages its debt reasonably well – and to its own benefit. When we think about a company’s use of debt, we first look at cash and debt together.

Check out our latest review for Outokumpu Oyj

What is Outokumpu Oyj’s debt?

You can click on the chart below for historical figures, but it shows Outokumpu Oyj had €522.0m in debt in December 2021, up from €1.21bn a year earlier. On the other hand, he has €328.0 million in cash, resulting in a net debt of around €194.0 million.

HLSE:OUT1V Debt to Equity History April 21, 2022

A look at the responsibilities of Outokumpu Oyj

The latest balance sheet data shows that Outokumpu Oyj had liabilities of €2.37 billion due within one year, and liabilities of €994.0 million falling due thereafter. On the other hand, it has cash of €328.0 million and €761.0 million in receivables at less than one year. It therefore has liabilities totaling 2.27 billion euros more than its cash and short-term receivables, combined.

Given that this deficit is actually greater than the company’s market capitalization of 2.20 billion euros, we believe that shareholders should really watch Outokumpu Oyj’s debt level, like a parent watching his child riding a bicycle for the first time. In the scenario where the company were to quickly clean up its balance sheet, it seems likely that shareholders would suffer significant dilution.

We measure a company’s leverage against its earning power by looking at its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and calculating how easily its earnings before interest and taxes (EBIT ) covers its interest charge (interest coverage). The advantage of this approach is that we consider both the absolute amount of debt (with net debt to EBITDA) and the actual interest expense associated with that debt (with its interest coverage ratio ).

Outokumpu Oyj’s net debt is only 0.21 times its EBITDA. And its EBIT easily covers its interest costs, being 12.0 times greater. One could therefore say that he is no more threatened by his debt than an elephant is by a mouse. It was also good to see that despite losing money on the EBIT line last year, Outokumpu Oyj turned things around over the last 12 months, delivering an EBIT of EUR 696 million. There is no doubt that we learn the most about debt from the balance sheet. But ultimately, the company’s future profitability will decide whether Outokumpu Oyj can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free analyst earnings forecast report interesting.

But our last consideration is also important, because a company cannot pay debt with paper profits; he needs cash. It is therefore worth checking how much of earnings before interest and tax (EBIT) is supported by free cash flow. In the most recent year, Outokumpu Oyj recorded free cash flow of 63% of its EBIT, which is about normal given that free cash flow excludes interest and taxes. This free cash flow puts the company in a good position to repay its debt, should it arise.

Our point of view

Outokumpu Oyj’s ability to cover its interest expense with its EBIT and net debt to EBITDA has given us comfort in its ability to manage its debt. That said, its level of total liabilities makes us somewhat aware of potential future risks to the balance sheet. Looking at all this data, we feel a bit cautious about Outokumpu Oyj’s debt levels. While debt has its upside in higher potential returns, we think shareholders should certainly consider how debt levels could make the stock more risky. There is no doubt that we learn the most about debt from the balance sheet. However, not all investment risks reside on the balance sheet, far from it. For example, we found 4 warning signs for Outokumpu Oyj (1 is a little unpleasant!) which you should be aware of before investing here.

If, after all that, you’re more interested in a fast-growing company with a strong balance sheet, check out our list of cash-flowing growth stocks without further ado.

This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.

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