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. Above all, Kaiser Aluminum Corporation (NASDAQ:KALU) is in debt. But should shareholders worry about its use of debt?
Why is debt risky?
Generally speaking, debt only becomes a real problem when a company cannot easily repay it, either by raising capital or with its own cash flow. Ultimately, if the company cannot meet its legal debt repayment obligations, shareholders could walk away with nothing. However, a more common (but still painful) scenario is that it has to raise new equity at a low price, thereby permanently diluting shareholders. That said, the most common situation is when a company manages its debt reasonably well – and to its own benefit. The first thing to do when considering how much debt a business has is to look at its cash flow and debt together.
Check out our latest review for Kaiser Aluminum
What is Kaiser Aluminum’s debt?
The image below, which you can click on for more details, shows that as of September 2021, Kaiser Aluminum had $1.04 billion in debt, up from $837.6 million in one year. On the other hand, he has $295.7 million in cash, resulting in a net debt of around $740.2 million.
How healthy is Kaiser Aluminum’s balance sheet?
The latest balance sheet data shows Kaiser Aluminum had liabilities of $444.8 million due within the year, and liabilities of $1.27 billion due thereafter. On the other hand, it had liquidities of 295.7 million dollars and 446.3 million dollars of receivables at less than one year. Thus, its liabilities outweigh the sum of its cash and receivables (current) by $974.2 million.
This shortfall is not that bad as Kaiser Aluminum is worth $1.67 billion and therefore could probably raise enough capital to shore up its balance sheet, should the need arise. But we definitely want to keep our eyes peeled for indications that its debt is too risky.
We use two main ratios to inform us about debt to earnings levels. The first is net debt divided by earnings before interest, taxes, depreciation and amortization (EBITDA), while the second is how often its earnings before interest and taxes (EBIT) covers its interest expense (or its interests, for short). In this way, we consider both the absolute amount of debt, as well as the interest rates paid on it.
While we are not concerned about Kaiser Aluminum’s net debt to EBITDA ratio of 4.8, we believe its extremely low interest coverage of 1.6 times is a sign of high leverage. It seems clear that the cost of borrowing money is having a negative impact on shareholder returns lately. Worse still, Kaiser Aluminum’s EBIT is down 25% from a year ago. If earnings continue to follow this trajectory, paying off that debt will be harder than convincing us to run a marathon in the rain. There is no doubt that we learn the most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Kaiser Aluminum’s ability to maintain a healthy balance sheet in the future. So if you are focused on the future, you can check out this free report showing analyst earnings forecast.
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, Kaiser Aluminum 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
To be frank, Kaiser Aluminum’s interest coverage and history of (non-)growing EBIT makes us rather uncomfortable with its level of leverage. But on the bright side, its conversion from EBIT to free cash flow is a good sign and makes us more optimistic. Once we consider all of the above factors together, it seems to us that Kaiser Aluminum’s debt makes it a bit risky. This isn’t necessarily a bad thing, but we would generally feel more comfortable with less leverage. There is no doubt that we learn the most about debt from the balance sheet. But at the end of the day, every business can contain risks that exist outside of the balance sheet. For example, we found 2 warning signs for Kaiser Aluminum (1 is concerning!) that 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-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.
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