Is Warrior Met Coal (NYSE:HCC) using too much debt?
Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett said “volatility is far from synonymous with risk.” It’s natural to consider a company’s balance sheet when looking at its riskiness, as debt is often involved when a company fails. We can see that Warrior Met Coal, Inc. (NYSE: HCC) uses debt in its operations. But should shareholders worry about its use of debt?
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. In the worst case, a company can go bankrupt if it cannot pay its creditors. 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. Of course, debt can be an important tool in businesses, especially capital-intensive businesses. When we think about a company’s use of debt, we first look at cash and debt together.
See our latest analysis for Warrior Met Coal
What is Warrior Met Coal’s net debt?
You can click on the chart below for historical numbers, but it shows Warrior Met Coal had $340.5 million in debt in September 2021, up from $379.7 million a year prior. However, since he has a cash reserve of $276.9 million, his net debt is less, at around $63.6 million.
How healthy is Warrior Met Coal’s balance sheet?
The latest balance sheet data shows that Warrior Met Coal had liabilities of $134.4 million due within the year, and liabilities of $474.9 million due thereafter. As compensation for these obligations, it had cash of US$276.9 million and receivables valued at US$73.3 million due within 12 months. Thus, its liabilities outweigh the sum of its cash and receivables (current) by $259.1 million.
Given that Warrior Met Coal has a market cap of US$1.33 billion, it’s hard to believe that these liabilities pose much of a threat. But there are enough liabilities that we certainly recommend that shareholders continue to monitor the balance sheet in the future.
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). Thus, we consider debt to earnings with and without depreciation and amortization charges.
Given that net debt is only 0.35x EBITDA, it is initially surprising to see that Warrior Met Coal’s EBIT has a low interest coverage of 1.0x. So, one way or another, it is clear that debt levels are not negligible. Warrior Met Coal increased its EBIT by 2.6% over the past year. While that barely brings us down, it’s a positive when it comes to debt. The balance sheet is clearly the area to focus on when analyzing debt. But it is future earnings, more than anything, that will determine Warrior Met Coal’s ability to maintain a healthy balance sheet in the future. So if you want to see what the professionals think, you might find this free analyst earnings forecast report interesting.
Finally, a business needs free cash flow to pay off its debts; book profits are not enough. So the logical step is to look at what proportion of that EBIT is actual free cash flow. Over the past three years, Warrior Met Coal has actually produced more free cash flow than EBIT. This kind of strong cash generation warms our hearts like a puppy in a bumblebee suit.
Our point of view
Warrior Met Coal’s conversion of EBIT to free cash flow suggests he can manage his debt as easily as Cristiano Ronaldo could score a goal against an Under-14 keeper. But we have to admit that we find that its interest coverage has the opposite effect. All told, it looks like Warrior Met Coal can comfortably manage its current level of debt. Of course, while this leverage can improve return on equity, it comes with more risk, so it’s worth keeping an eye out for. Although Warrior Met Coal didn’t make a statutory profit last year, its positive EBIT suggests profitability may not be far off. Click here to see if its earnings are heading in the right direction, in the medium term.
If, after all that, you’re more interested in a fast-growing company with a strong balance sheet, check out our list of cash-neutral growth stocks right away.
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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.