Is Yara International (OB: YAR) using too much debt?

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Legendary fund manager Li Lu (who Charlie Munger supported) once said, “The biggest risk in investing is not price volatility, but the possibility that you will suffer a permanent loss of capital. So it seems like smart money knows that debt – which is usually involved in bankruptcies – is a very important factor, when you assess the level of risk of a business. We note that Yara International ASA (OB: YAR) has debt on its balance sheet. But the most important question is: what risk does this debt create?

When Is Debt a Problem?

Debt helps a business until the business struggles to repay it, either with new capital or with free cash flow. Ultimately, if the company cannot meet its legal debt repayment obligations, shareholders could walk away with nothing. However, a more common (but still painful) scenario is that he must raise new equity at low cost, thereby diluting shareholders over the long term. Of course, many companies use debt to finance their growth without negative consequences. The first step in examining a company’s debt levels is to consider its cash flow and debt together.

Check out our latest review for Yara International

What is Yara International’s debt?

As you can see below, Yara International was in debt of US $ 3.52 billion, as of September 2021, which is roughly the same as the year before. You can click on the graph for more details. However, given that it has a cash reserve of US $ 488.0 million, its net debt is less, at around US $ 3.03 billion.

OB: YAR History of debt to equity November 12, 2021

Is Yara International’s balance sheet healthy?

According to the latest published balance sheet, Yara International had liabilities of US $ 4.31 billion due within 12 months and liabilities of US $ 4.77 billion due beyond 12 months. On the other hand, he had $ 488.0 million in cash and $ 1.77 billion in receivables within a year. As a result, its liabilities exceed the sum of its cash and (short-term) receivables by $ 6.82 billion.

This deficit is not that big as Yara International is worth US $ 13.6 billion and could therefore probably raise enough capital to consolidate its balance sheet, should the need arise. But we absolutely want to keep our eyes open for indications that its debt is too risky.

In order to measure a company’s debt relative to its profits, we calculate its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and its profit before interest and taxes (EBIT) divided by its interest. debtors (its interest coverage). Thus, we consider debt versus earnings with and without amortization charges.

Yara International has a low net debt to EBITDA ratio of just 1.3. And its EBIT easily covers its interest costs, being 26.4 times higher. We could therefore say that he is no more threatened by his debt than an elephant is by a mouse. On top of that, we are happy to report that Yara International has increased its EBIT by 38%, reducing the specter of future debt repayments. When analyzing debt levels, the balance sheet is the obvious starting point. But ultimately, the company’s future profitability will decide whether Yara International can strengthen its balance sheet over time. So if you are focused on the future you can check this out free report showing analysts’ earnings forecasts.

But our last consideration is also important, because a business cannot pay its debts with paper profits; he needs hard cash. We must therefore clearly check whether this EBIT generates a corresponding free cash flow. Over the past three years, Yara International has generated strong free cash flow equivalent to 77% of its EBIT, roughly what we expected. This free cash flow puts the business in a good position to repay debt, if any.

Our point of view

Fortunately, Yara International’s impressive interest coverage means it has the upper hand over its debt. But, on a darker note, we’re a little concerned with its total liability level. Looking at the big picture, we think Yara International’s use of debt looks very reasonable and we don’t care. After all, reasonable leverage can increase returns on equity. When analyzing debt levels, the balance sheet is the obvious starting point. But at the end of the day, every business can contain risks that exist off the balance sheet. For example – Yara International has 3 warning signs we think you should be aware.

If, after all of this, you’re more interested in a fast-growing company with a strong balance sheet, take a quick look at our list of cash net growth stocks.

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

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