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Warren Buffett famously said, “Volatility is nowhere near synonymous with risk.” It is only natural to consider a company’s balance sheet when considering how risky it is, as debt is often at play when a company breaks down. We make a note of that Ternium SA (NYSE: TX) has debt on its balance sheet. But should shareholders be concerned about the use of debt?
When is debt a problem?
Debt supports a company until the company has difficulty paying it, either with new capital or with free cash flow. Ultimately, if the company fails to meet its legal debt-repayment obligations, shareholders will end up doing nothing. While this isn’t too common, we often see indebted companies permanently diluting their shareholders by forcing lenders to raise capital at a distressed price. However, by replacing the dilution, debt can be an extremely good tool for companies that need capital to invest in growth with high returns. When we think about using a company’s debt, let’s first look at cash and debt together.
Check out our latest analysis for Ternium
What is Ternium’s Net Debt?
As you can see below, Ternium had $ 1.57 billion in debt in June 2021, up from $ 2.08 billion the previous year. However, it also had $ 1.38 billion in cash, so its net debt is $ 188.2 million.
A look at Ternium’s liabilities
The latest balance sheet shows that Ternium had liabilities of $ 2.85 billion in one year and liabilities of $ 2.06 billion beyond that. To offset these commitments, the company had $ 1.38 billion in cash and $ 2.07 billion in receivables due within 12 months. So his debt is $ 1.45 billion more than the combination of cash and short-term receivables.
With publicly traded Ternium stock valued at a very impressive total of $ 10.1 billion, it seems unlikely that this level of debt would pose a major threat. However, we think it’s worth keeping an eye on balance sheet strength as it can change over time.
To estimate a company’s debt in relation to its profits, we calculate its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and its earnings before interest and taxes (EBIT) divided by its interest expense (its interest coverage). The advantage of this approach is that we take into account both the absolute level of debt (with net debt to EBITDA) and the actual interest expenses associated with this debt (with its interest coverage ratio).
Ternium has very modest net debt with net debt only 0.052 times EBITDA. Humourously, in the past twelve months, she’s even got more interest than she had to pay. So there’s no doubt that this company can get into debt just as easily as avid spray tanners turn an orange hue. Better still, Ternium increased its EBIT by 489% last year, which is an impressive improvement. This boost will make debt repayment even easier in the future. Undoubtedly, we learn the most about balance sheet debt. But ultimately, the company’s future profitability will determine whether Ternium can strengthen its balance sheet over time. So, if you want to know what the professionals are thinking, this free analyst earnings forecast report might be of interest.
After all, a business needs free cash flow to pay off debts; Accounting profits just don’t cut it off. So it is worth checking how much of this EBIT is covered by free cash flow. For the past three years, Ternium has posted free cash flow of 61% of its EBIT, which is roughly normal as the free cash flow is excluding interest and taxes. This cold money means it can get rid of its debt if it wants to.
Our view
Ternium’s interest coverage suggests it can manage its debt as easily as Cristiano Ronaldo could score against a goalkeeper under 14. And the good news doesn’t stop there, because the EBIT growth rate also supports this impression! Overall, we don’t think Ternium is taking any major risks as its debt burden appears modest. So we don’t worry about using a small leverage on the balance sheet. Undoubtedly, we learn the most about balance sheet debt. But ultimately, any business can involve off-balance sheet risks. To do this, you should find out about the 3 warning signs We discovered Ternium (including 1 which is a bit uncomfortable).
Ultimately, sometimes it’s easier to focus on businesses that don’t even need debt. Readers can access a list of growth stocks with no net debt 100% free, at the moment.
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This article from Simply Wall St is of a general nature. We only provide comments based on historical data and analyst projections using an unbiased methodology, and our articles are not intended as financial advice. It is not a recommendation to buy or sell stocks and does not take into account your goals or your financial situation. Our goal is to provide you with long-term, focused analysis based on fundamentals. Note that our analysis may not take into account the latest company announcements or quality material, which may be sensitive to the price. Simply Wall St has no position in the stocks mentioned.
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