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David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' 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. We note that Yara International ASA (OB:YAR) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.
Why Does Debt Bring Risk?
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. If things get really bad, the lenders can take control of the business. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
See our latest analysis for Yara International
What Is Yara International's Debt?
You can click the graphic below for the historical numbers, but it shows that Yara International had US$3.93b of debt in June 2019, down from US$4.15b, one year before. However, it does have US$320.0m in cash offsetting this, leading to net debt of about US$3.61b.
How Healthy Is Yara International's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Yara International had liabilities of US$4.13b due within 12 months and liabilities of US$4.43b due beyond that. On the other hand, it had cash of US$320.0m and US$1.91b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$6.33b.
While this might seem like a lot, it is not so bad since Yara International has a huge market capitalization of US$11.7b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.
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). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).