We Think LafargeHolcim (VTX:LHN) Can Stay On Top Of Its Debt
Simply Wall St
Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We can see that LafargeHolcim Ltd (VTX:LHN) does use debt in its business. But should shareholders be worried about its use of debt?
What Risk Does Debt Bring?
Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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.
You can click the graphic below for the historical numbers, but it shows that LafargeHolcim had CHF14.3b of debt in June 2019, down from CHF18.7b, one year before. However, it does have CHF3.05b in cash offsetting this, leading to net debt of about CHF11.2b.
SWX:LHN Historical Debt, August 13th 2019
How Strong Is LafargeHolcim's Balance Sheet?
According to the last reported balance sheet, LafargeHolcim had liabilities of CHF9.83b due within 12 months, and liabilities of CHF18.6b due beyond 12 months. Offsetting these obligations, it had cash of CHF3.05b as well as receivables valued at CHF3.87b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CHF21.5b.
This deficit is considerable relative to its very significant market capitalization of CHF28.2b, so it does suggest shareholders should keep an eye on LafargeHolcim's use of debt. This suggests shareholders would heavily diluted if the company needed to shore up its balance sheet in a hurry.
We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.
LafargeHolcim has net debt worth 1.9 times EBITDA, which isn't too much, but its interest cover looks a bit on the low side, with EBIT at only 6.5 times the interest expense. While that doesn't worry us too much, it does suggest the interest payments are somewhat of a burden. We also note that LafargeHolcim improved its EBIT from a last year's loss to a positive CHF3.4b. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine LafargeHolcim's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.
Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it's worth checking how much of the earnings before interest and tax (EBIT) is backed by free cash flow. During the last year, LafargeHolcim produced sturdy free cash flow equating to 74% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.
Our View
On our analysis LafargeHolcim's conversion of EBIT to free cash flow should signal that it won't have too much trouble with its debt. However, our other observations weren't so heartening. For instance it seems like it has to struggle a bit to handle its total liabilities. Looking at all this data makes us feel a little cautious about LafargeHolcim's debt levels. While debt does have its upside in higher potential returns, we think shareholders should definitely consider how debt levels might make the stock more risky. Given LafargeHolcim has a strong balance sheet is profitable and pays a dividend, it would be good to know how fast its dividends are growing, if at all. You can find out instantly by clicking this link.
Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.
We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.
If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.
