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Is Alara Resources (ASX:AUQ) Using Too Much Debt?

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 seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We can see that Alara Resources Limited (ASX:AUQ) does use debt in its business. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for Alara Resources

What Is Alara Resources's Debt?

The image below, which you can click on for greater detail, shows that at June 2019 Alara Resources had debt of AU$644.2k, up from AU$583.8k in one year. But on the other hand it also has AU$12.3m in cash, leading to a AU$11.6m net cash position.

ASX:AUQ Historical Debt, October 9th 2019
ASX:AUQ Historical Debt, October 9th 2019

How Strong Is Alara Resources's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Alara Resources had liabilities of AU$2.26m due within 12 months and liabilities of AU$680.5k due beyond that. Offsetting these obligations, it had cash of AU$12.3m as well as receivables valued at AU$155.6k due within 12 months. So it can boast AU$9.48m more liquid assets than total liabilities.

This luscious liquidity implies that Alara Resources's balance sheet is sturdy like a giant sequoia tree. On this basis we think its balance sheet is strong like a sleek panther or even a proud lion. Simply put, the fact that Alara Resources 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 Alara Resources's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Since Alara Resources has no significant operating revenue, shareholders probably hope it will develop a valuable new mine before too long.

So How Risky Is Alara Resources?

By their very nature companies that are losing money are more risky than those with a long history of profitability. And the fact is that over the last twelve months Alara Resources lost money at the earnings before interest and tax (EBIT) line. Indeed, in that time it burnt through AU$2.2m of cash and made a loss of AU$455k. While this does make the company a bit risky, it's important to remember it has net cash of AU$11.6m. That means it could keep spending at its current rate for more than two years. The good news for shareholders is that Alara Resources has dazzling revenue growth, so there's a very good chance it can boost its free cash flow in the years to come. While unprofitable companies can be risky, they can also grow hard and fast in those pre-profit years. When I consider a company to be a bit risky, I think it is responsible to check out whether insiders have been reporting any share sales. Luckily, you can click here ito see our graphic depicting Alara Resources insider transactions.

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.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.

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