Warrior Met Coal (NYSE: HCC) has a pretty healthy track record

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Berkshire Hathaway’s Charlie Munger-backed external fund manager Li Lu is quick to say “The biggest risk in investing is not price volatility, but whether you will suffer a permanent loss of capital”. It’s only natural to consider a company’s balance sheet when looking at its level of risk, as debt is often involved when a business collapses. Like many other companies Warrior Met Coal, Inc. (NYSE: HCC) uses debt. But the most important question is: what risk does this debt create?

Why Does Debt Bring Risk?

Debt is a tool to help businesses grow, but if a business is unable to repay its lenders, then it exists at their mercy. In the worst case scenario, a business can go bankrupt if it cannot pay its creditors. While it’s not too common, we often see indebted companies continually diluting their shareholders because lenders are forcing them to raise capital at a ridiculous price. Of course, the advantage of debt is that it often represents cheap capital, especially when it replaces dilution in a business with the ability to reinvest at high rates of return. When we think of a business’s use of debt, we first look at cash flow and debt together.

How much debt does Warrior Met Coal carry?

You can click on the graph below for historical numbers, but it shows that Warrior Met Coal had $ 340.5 million in debt as of September 2021, up from $ 379.7 million a year earlier. However, it has $ 276.9 million in cash offsetting that, which leads to net debt of around $ 63.6 million.

NYSE: HCC Debt to Equity History November 5, 2021

How strong is Warrior Met Coal’s balance sheet?

The latest balance sheet data shows Warrior Met Coal had $ 134.4 million in liabilities due within one year, and $ 474.9 million in liabilities due thereafter. On the other hand, it had US $ 276.9 million in cash and US $ 73.3 million in receivables due within one year. As a result, its liabilities exceed the sum of its cash and (short-term) receivables by $ 259.1 million.

While that might sound like a lot, it’s not that bad since Warrior Met Coal has a market cap of $ 1.18 billion, so it could likely strengthen its balance sheet by raising capital if needed. But we absolutely want to keep our eyes open for indications that its debt is too risky.

We use two main ratios to inform us about the levels of debt compared to earnings. The first is net debt divided by earnings before interest, taxes, depreciation, and amortization (EBITDA), while the second is the number of times its profit before interest and taxes (EBIT) covers its interest expense (or its coverage of interest, for short). The advantage of this approach is that we take into account both the absolute amount of debt (with net debt versus EBITDA) and the actual interest charges associated with this debt (with its coverage rate). interests).

Warrior Met Coal has a very low debt to EBITDA ratio of 0.35 so it is strange to see low interest coverage as last year’s EBIT was only 1.0 times interest expense . So while we are not necessarily alarmed, we think his debt is far from negligible. Warrior Met Coal increased its EBIT by 2.6% last year. It’s far from incredible, but it’s a good thing when it comes to paying down debt. When analyzing debt levels, the balance sheet is the obvious starting point. But ultimately, the company’s future profitability will decide whether Warrior Met Coal 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.

Finally, while the IRS may love accounting profits, lenders only accept hard cash. It is therefore worth checking to what extent this EBIT is supported by free cash flow. Fortunately for all shareholders, Warrior Met Coal has actually generated more free cash flow than EBIT over the past three years. There is nothing better than cash flow to stay in the good graces of your lenders.

Our point of view

The good news is that Warrior Met Coal’s demonstrated ability to convert EBIT into free cash flow delights us like a fluffy puppy does a toddler. But you have to admit that its hedging interest has the opposite effect. Looking at all of the aforementioned factors together, it seems to us that Warrior Met Coal can handle its debt quite comfortably. Of course, while this leverage can improve returns on equity, it comes with more risk, so it’s worth keeping an eye out for. The balance sheet is clearly the area you need to focus on when analyzing debt. But at the end of the day, every business can contain risks that exist off the balance sheet. To do this, you need to know the 1 warning sign we spotted with Warrior Met Coal.

Of course, if you are the type of investor who prefers to buy stocks without going into debt, feel free to check out our exclusive list of cash net growth stocks today.

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

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