Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about. It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. Importantly, CI Resources Limited (ASX:CII) does carry debt. But is this debt a concern to shareholders?
Why Does Debt Bring Risk?
Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.
What Is CI Resources's Debt?
You can click the graphic below for the historical numbers, but it shows that as of June 2019 CI Resources had AU$13.2m of debt, an increase on none, over one year. But on the other hand it also has AU$47.1m in cash, leading to a AU$33.9m net cash position.
How Healthy Is CI Resources's Balance Sheet?
According to the last reported balance sheet, CI Resources had liabilities of AU$19.7m due within 12 months, and liabilities of AU$38.0m due beyond 12 months. Offsetting this, it had AU$47.1m in cash and AU$28.6m in receivables that were due within 12 months. So it actually has AU$18.0m more liquid assets than total liabilities.
This short term liquidity is a sign that CI Resources could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, CI Resources boasts net cash, so it's fair to say it does not have a heavy debt load!
In fact CI Resources's saving grace is its low debt levels, because its EBIT has tanked 41% in the last twelve months. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. There's no doubt that we learn most about debt from the balance sheet. But it is CI Resources's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.
Finally, a company can only pay off debt with cold hard cash, not accounting profits. While CI Resources has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Looking at the most recent three years, CI Resources recorded free cash flow of 33% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.
While we empathize with investors who find debt concerning, you should keep in mind that CI Resources has net cash of AU$33.9m, as well as more liquid assets than liabilities. So we don't have any problem with CI Resources's use of debt. Over time, share prices tend to follow earnings per share, so if you're interested in CI Resources, you may well want to click here to check an interactive graph of its earnings per share history.
At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.
If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. 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.
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