We think Amcor (ASX:AMC) can stay on top of its debt

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett said “volatility is far from synonymous with risk.” When we think of a company’s risk, we always like to look at its use of debt, because over-indebtedness can lead to ruin. We notice that Amcor plc (ASX:AMC) has debt on its balance sheet. But should shareholders worry about its use of debt?

When is debt dangerous?

Debt and other liabilities become risky for a business when it cannot easily meet those obligations, either with free cash flow or by raising capital at an attractive price. Ultimately, if the company cannot meet its legal debt repayment obligations, shareholders could walk away with nothing. Although not too common, we often see companies in debt permanently diluting their shareholders because lenders force 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 about a company’s use of debt, we first look at cash and debt together.

See our latest analysis for Amcor

What is Amcor’s debt?

As you can see below, Amcor had $6.59 billion in debt, as of September 2021, which is about the same as the year before. You can click on the graph for more details. However, he has $634.0 million in cash to offset this, resulting in a net debt of approximately $5.96 billion.

ASX:AMC Debt to Equity January 20, 2022

How strong is Amcor’s balance sheet?

Zooming in on the latest balance sheet data, we can see that Amcor had liabilities of US$4.02 billion due within 12 months and liabilities of US$8.32 billion due beyond. On the other hand, it had cash of $634.0 million and $1.94 billion in receivables within one year. It therefore has liabilities totaling $9.77 billion more than its cash and short-term receivables, combined.

This shortfall is not that bad because Amcor is worth US$18.6 billion and therefore could probably raise enough capital to shore up its balance sheet, should the need arise. But it is clear that it is essential to examine closely whether it can manage its debt without dilution.

In order to assess a company’s debt relative to its earnings, we calculate its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and its earnings before interest and taxes (EBIT) divided by its expenses. interest (its interest coverage). Thus, we consider debt to earnings with and without amortization and depreciation expense.

Amcor has a debt to EBITDA ratio of 2.9, which signals significant debt, but is still fairly reasonable for most types of businesses. However, its interest coverage of 10.7 is very high, suggesting that debt interest charges are currently quite low. One way for Amcor to overcome its debt would be to stop borrowing more but continue to grow EBIT by around 11%, as it did last year. There is no doubt that we learn the most about debt from the balance sheet. But future earnings, more than anything, will determine Amcor’s ability to maintain a healthy balance sheet in the future. So if you want to see what the professionals think, you might find this free analyst earnings forecast report interesting.

Finally, a business needs free cash flow to pay off its debts; book profits are not enough. We must therefore clearly examine whether this EBIT generates a corresponding free cash flow. Over the past three years, Amcor has produced strong free cash flow equivalent to 69% of its EBIT, which is what we expected. This free cash flow puts the company in a good position to repay its debt, should it arise.

Our point of view

Amcor’s ability to cover its interest costs with its EBIT and its conversion of EBIT to free cash flow have reinforced our ability to manage its debt. On the other hand, its net debt to EBITDA makes us a little less comfortable about its debt. When we consider all the elements cited above, it seems to us that Amcor manages its debt quite well. That said, the charge is heavy enough that we recommend that any shareholder keep a close eye on it. The balance sheet is clearly the area to focus on when analyzing debt. However, not all investment risks reside on the balance sheet, far from it. These risks can be difficult to spot. Every business has them, and we’ve spotted 2 warning signs for Amcor you should know.

Of course, if you’re the type of investor who prefers to buy stocks without the burden of debt, then feel free to check out our exclusive list of cash-efficient growth stocks today.

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

Source link

John A. Bogar