Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. Importantly, Loma Negra Compañía Industrial Argentina Sociedad Anónima (NYSE:LOMA) does carry debt. But should shareholders be worried about its use of debt?
What Risk Does Debt Bring?
Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
What Is Loma Negra Compañía Industrial Argentina Sociedad Anónima's Debt?
The image below, which you can click on for greater detail, shows that at September 2019 Loma Negra Compañía Industrial Argentina Sociedad Anónima had debt of AR$10.4b, up from AR$7.33b in one year. On the flip side, it has AR$1.35b in cash leading to net debt of about AR$9.06b.
A Look At Loma Negra Compañía Industrial Argentina Sociedad Anónima's Liabilities
The latest balance sheet data shows that Loma Negra Compañía Industrial Argentina Sociedad Anónima had liabilities of AR$15.2b due within a year, and liabilities of AR$11.1b falling due after that. Offsetting this, it had AR$1.35b in cash and AR$3.66b in receivables that were due within 12 months. So it has liabilities totalling AR$21.3b more than its cash and near-term receivables, combined.
While this might seem like a lot, it is not so bad since Loma Negra Compañía Industrial Argentina Sociedad Anónima has a market capitalization of AR$41.5b, 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.
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.
While Loma Negra Compañía Industrial Argentina Sociedad Anónima's low debt to EBITDA ratio of 1.2 suggests only modest use of debt, the fact that EBIT only covered the interest expense by 6.3 last year does give us pause. So we'd recommend keeping a close eye on the impact financing costs are having on the business. But the other side of the story is that Loma Negra Compañía Industrial Argentina Sociedad Anónima saw its EBIT decline by 7.7% over the last year. That sort of decline, if sustained, will obviously make debt harder to handle. 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 Loma Negra Compañía Industrial Argentina Sociedad Anónima'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, a company can only pay off debt with cold hard cash, not accounting profits. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Considering the last three years, Loma Negra Compañía Industrial Argentina Sociedad Anónima actually recorded a cash outflow, overall. Debt is far more risky for companies with unreliable free cash flow, so shareholders should be hoping that the past expenditure will produce free cash flow in the future.
Mulling over Loma Negra Compañía Industrial Argentina Sociedad Anónima's attempt at converting EBIT to free cash flow, we're certainly not enthusiastic. But on the bright side, its net debt to EBITDA is a good sign, and makes us more optimistic. Once we consider all the factors above, together, it seems to us that Loma Negra Compañía Industrial Argentina Sociedad Anónima's debt is making it a bit risky. That's not necessarily a bad thing, but we'd generally feel more comfortable with less leverage. Over time, share prices tend to follow earnings per share, so if you're interested in Loma Negra Compañía Industrial Argentina Sociedad Anónima, you may well want to click here to check an interactive graph of its earnings per share history.
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.
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