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 risk.” When we think about the risk level of a business, we always like to look at its use of debt because debt overload can lead to bankruptcy. Like many other companies Livent Company (NYSE: LTHM) uses debt. But the most important question is: what is the risk that this debt creates?

When is debt a problem?

Debt and other liabilities become risky for a business when it cannot easily meet these obligations, either with free cash flow or by raising capital at an attractive price. An integral part of capitalism is the process of “creative destruction” where bankrupt companies are ruthlessly liquidated by their bankers. However, a more common (but still costly) situation is where a company has to dilute its shareholders at a cheap stock price just to get its debt under control. 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. The first thing to do when considering how much debt a business uses is to look at its cash flow and debt together.

Check out our latest review for Livent

What is Livent’s debt?

As you can see below, at the end of December 2020, Livent had $ 236.7 million in debt, down from $ 154.6 million a year ago. Click on the image for more details. However, because it has a cash reserve of US $ 11.6 million, its net debt is lower, at around US $ 225.1 million.

How strong is Livent’s balance sheet?

We can see from the most recent balance sheet that Livent had liabilities of US $ 82.3 million due in one year, and liabilities of US $ 288.7 million beyond. In return, he had US $ 11.6 million in cash and US $ 111.4 million in receivables due within 12 months. As a result, its liabilities total $ 248.0 million more than the combination of its cash and short-term receivables.

Of course, Livent has a market cap of US $ 2.43 billion, so those liabilities are likely manageable. However, we think it’s worth keeping an eye on the strength of its balance sheet as it can change over time. When analyzing debt levels, the balance sheet is the obvious starting point. But it is future profits, more than anything, that will determine Livent’s ability to maintain a healthy balance sheet in the future. So if you are focused on the future you can check out this free report showing analysts’ earnings forecasts.

Year over 12 months, Livent recorded a loss in EBIT and saw sales fall to $ 288 million, a decrease of 26%. It makes us nervous, to say the least.

Caveat Emptor

Not only has Livent’s revenue slipped over the past twelve months, it has also produced negative earnings before interest and taxes (EBIT). In fact, it lost US $ 11 million in EBIT. When we look at this and recall the liabilities of its balance sheet, versus the cash flow, it seems unwise to us that the company is in debt. Frankly, we think the record is far from adequate, although it could improve over time. Another reason for caution is that negative free cash flow has been bled by US $ 118 million in the past twelve months. So suffice it to say that we consider the stock to be risky. There is no doubt that we learn the most about debt from the balance sheet. However, not all investment risks lie on the balance sheet – far from it. To this end, you should inquire about the 2 warning signs we spotted with Livent (including 1 which makes us a little uncomfortable).

If you want to invest in companies that can generate profits without the burden of debt, take a look at this free list of growing companies that have net cash on the balance sheet.

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