Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. As with many other companies American Axle & Manufacturing Holdings, Inc. (NYSE:AXL) makes use of debt. But is this debt a concern to shareholders?
What Risk Does Debt Bring?
Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
What Is American Axle & Manufacturing Holdings's Net Debt?
The image below, which you can click on for greater detail, shows that American Axle & Manufacturing Holdings had debt of US$3.27b at the end of June 2021, a reduction from US$4.20b over a year. However, it does have US$590.4m in cash offsetting this, leading to net debt of about US$2.68b.NYSE:AXL Debt to Equity History October 23rd 2021
A Look At American Axle & Manufacturing Holdings' Liabilities
The latest balance sheet data shows that American Axle & Manufacturing Holdings had liabilities of US$1.15b due within a year, and liabilities of US$4.25b falling due after that. Offsetting this, it had US$590.4m in cash and US$825.4m in receivables that were due within 12 months. So it has liabilities totalling US$3.99b more than its cash and near-term receivables, combined.
This deficit casts a shadow over the US$1.17b company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. At the end of the day, American Axle & Manufacturing Holdings would probably need a major re-capitalization if its creditors were to demand repayment.
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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.
American Axle & Manufacturing Holdings's debt is 2.6 times its EBITDA, and its EBIT cover its interest expense 2.6 times over. This suggests that while the debt levels are significant, we'd stop short of calling them problematic. Pleasingly, American Axle & Manufacturing Holdings is growing its EBIT faster than former Australian PM Bob Hawke downs a yard glass, boasting a 479% gain in the last twelve months. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine American Axle & Manufacturing Holdings's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we always check how much of that EBIT is translated into free cash flow. During the last three years, American Axle & Manufacturing Holdings produced sturdy free cash flow equating to 79% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.
While American Axle & Manufacturing Holdings's level of total liabilities has us nervous. For example, its EBIT growth rate and conversion of EBIT to free cash flow give us some confidence in its ability to manage its debt. Looking at all the angles mentioned above, it does seem to us that American Axle & Manufacturing Holdings is a somewhat risky investment as a result of its debt. Not all risk is bad, as it can boost share price returns if it pays off, but this debt risk is worth keeping in mind. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should learn about the 2 warning signs we've spotted with American Axle & Manufacturing Holdings (including 1 which is a bit concerning) .
If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.
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.
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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
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