CMC Metals Corporate Bonds and Leverage Analysis

CMC Metals Debt to Cash Allocation

CMC Metals has accumulated 38.45 K in total debt with debt to equity ratio (D/E) of 1.22, which is about average as compared to similar companies. CMC Metals has a current ratio of 0.02, indicating that it has a negative working capital and may not be able to pay financial obligations in time and when they become due. Debt can assist CMC Metals until it has trouble settling it off, either with new capital or with free cash flow. So, CMC Metals' shareholders could walk away with nothing if the company can't fulfill its legal obligations to repay debt. However, a more frequent occurrence is when companies like CMC Metals sell additional shares at bargain prices, diluting existing shareholders. Debt, in this case, can be an excellent and much better tool for CMC to invest in growth at high rates of return. When we think about CMC Metals' use of debt, we should always consider it together with cash and equity.

CMC Metals Total Assets Over Time

CMC Metals Assets Financed by Debt

The debt-to-assets ratio shows the degree to which CMC Metals uses debt to finance its assets. It includes both long-term and short-term borrowings maturing within one year. It also includes both tangible and intangible assets, such as goodwill.

CMC Metals Debt Ratio

62.0

It appears slightly above 38% of CMC Metals' assets are financed be debt. Typically, companies with high debt-to-asset ratios are said to be highly leveraged. The higher the ratio, the greater risk will be associated with the CMC Metals' operation. In addition, a high debt-to-assets ratio may indicate a low borrowing capacity of CMC Metals, which in turn will lower the firm's financial flexibility.

CMC Metals Corporate Bonds Issued

CMC Net Debt

Understaning CMC Metals Use of Financial Leverage

Additional Tools for CMC Stock Analysis

What is Financial Leverage?

Financial leverage is the use of borrowed money (debt) to finance the purchase of assets with the expectation that the income or capital gain from the new asset will exceed the cost of borrowing. In most cases, the debt provider will limit how much risk it is ready to take and indicate a limit on the extent of the leverage it will allow. In the case of asset-backed lending, the financial provider uses the assets as collateral until the borrower repays the loan. In the case of a cash flow loan, the general creditworthiness of the company is used to back the loan. The concept of leverage is common in the business world. It is mostly used to boost the returns on equity capital of a company, especially when the business is unable to increase its operating efficiency and returns on total investment. Because earnings on borrowing are higher than the interest payable on debt, the company's total earnings will increase, ultimately boosting stockholders' profits.

Leverage and Capital Costs

The debt to equity ratio plays a role in the working average cost of capital (WACC). The overall interest on debt represents the break-even point that must be obtained to profitability in a given venture. Thus, WACC is essentially the average interest an organization owes on the capital it has borrowed for leverage. Let's say equity represents 60% of borrowed capital, and debt is 40%. This results in a financial leverage calculation of 40/60, or 0.6667. The organization owes 10% on all equity and 5% on all debt. That means that the weighted average cost of capital is (.4)(5) + (.6)(10) - or 8%. For every $10,000 borrowed, this organization will owe $800 in interest. Profit must be higher than 8% on the project to offset the cost of interest and justify this leverage.

Benefits of Financial Leverage

Leverage provides the following benefits for companies:

• Leverage is an essential tool a company's management can use to make the best financing and investment decisions.
• It provides a variety of financing sources by which the firm can achieve its target earnings.
• Leverage is also an essential technique in investing as it helps companies set a threshold for the expansion of business operations. For example, it can be used to recommend restrictions on business expansion once the projected return on additional investment is lower than the cost of debt.

By borrowing funds, the firm incurs a debt that must be paid. But, this debt is paid in small installments over a relatively long period of time. This frees funds for more immediate use in the stock market. For example, suppose a company can afford a new factory but will be left with negligible free cash. In that case, it may be better to finance the factory and spend the cash on hand on inputs, labor, or even hold a significant portion as a reserve against unforeseen circumstances.

The Risk of Financial Leverage

The most obvious and apparent risk of leverage is that if price changes unexpectedly, the leveraged position can lead to severe losses. For example, imagine a hedge fund seeded by $50 worth of investor money. The hedge fund borrows another $50 and buys an asset worth $100, leading to a leverage ratio of 2:1. For the investor, this is neither good nor bad -- until the asset price changes. If the asset price goes up 10 percent, the investor earns $10 on $50 of capital, a net gain of 20 percent, and is very pleased with the increased gains from the leverage. However, if the asset price crashes unexpectedly, say by 30 percent, the investor loses $30 on $50 of capital, suffering a 60 percent loss. In other words, the effect of leverage is to increase the volatility of returns and increase the effects of a price change on the asset to the bottom line while increasing the chance for profit as well.