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Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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 note that Ternium S.A. (NYSE:TX) does have debt on its balance sheet. But is this debt a concern to shareholders?
When Is Debt Dangerous?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.
What Is Ternium's Debt?
You can click the graphic below for the historical numbers, but it shows that Ternium had US$1.36b of debt in March 2022, down from US$1.70b, one year before. However, its balance sheet shows it holds US$2.92b in cash, so it actually has US$1.56b net cash.
How Strong Is Ternium's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Ternium had liabilities of US$2.82b due within 12 months and liabilities of US$1.68b due beyond that. Offsetting this, it had US$2.92b in cash and US$2.33b in receivables that were due within 12 months. So it actually has US$750.9m more liquid assets than total liabilities.
This surplus suggests that Ternium has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Ternium has more cash than debt is arguably a good indication that it can manage its debt safely.
Better yet, Ternium grew its EBIT by 194% last year, which is an impressive improvement. That boost will make it even easier to pay down debt going forward. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Ternium can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Ternium has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Over the most recent three years, Ternium recorded free cash flow worth 53% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.
While it is always sensible to investigate a company's debt, in this case Ternium has US$1.56b in net cash and a decent-looking balance sheet. And it impressed us with its EBIT growth of 194% over the last year. So is Ternium's debt a risk? It doesn't seem so to us. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 2 warning signs for Ternium you should be aware of, and 1 of them shouldn't be ignored.
When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.
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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.