The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. Importantly, Adriatic Metals PLC (ASX:ADT) does carry debt. But the more important question is: how much risk is that debt creating?
When Is Debt A Problem?
Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.
How Much Debt Does Adriatic Metals Carry?
As you can see below, Adriatic Metals had UK£11.9m of debt, at December 2021, which is about the same as the year before. You can click the chart for greater detail. But on the other hand it also has UK£83.2m in cash, leading to a UK£71.3m net cash position.
How Strong Is Adriatic Metals' Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Adriatic Metals had liabilities of UK£4.16m due within 12 months and liabilities of UK£14.2m due beyond that. Offsetting these obligations, it had cash of UK£83.2m as well as receivables valued at UK£1.64m due within 12 months. So it actually has UK£66.5m more liquid assets than total liabilities.
This surplus suggests that Adriatic Metals is using debt in a way that is appears to be both safe and conservative. Given it has easily adequate short term liquidity, we don't think it will have any issues with its lenders. Simply put, the fact that Adriatic Metals has more cash than debt is arguably a good indication that it can manage its debt safely. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Adriatic Metals's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.
Given its lack of meaningful operating revenue, investors are probably hoping that Adriatic Metals finds some valuable resources, before it runs out of money.
So How Risky Is Adriatic Metals?
Statistically speaking companies that lose money are riskier than those that make money. And in the last year Adriatic Metals had an earnings before interest and tax (EBIT) loss, truth be told. Indeed, in that time it burnt through UK£18m of cash and made a loss of UK£10m. However, it has net cash of UK£71.3m, so it has a bit of time before it will need more capital. Even though its balance sheet seems sufficiently liquid, debt always makes us a little nervous if a company doesn't produce free cash flow regularly. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. These risks can be hard to spot. Every company has them, and we've spotted 4 warning signs for Adriatic Metals (of which 2 are potentially serious!) you should know about.
If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.
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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.