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David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' 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. As with many other companies Aeris Resources Limited (ASX:AIS) makes use of debt. But should shareholders be worried about its use of debt?
Why Does Debt Bring Risk?
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. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.
How Much Debt Does Aeris Resources Carry?
As you can see below, Aeris Resources had AU$27.4m of debt at June 2021, down from AU$49.0m a year prior. But it also has AU$103.5m in cash to offset that, meaning it has AU$76.1m net cash.
How Healthy Is Aeris Resources' Balance Sheet?
According to the last reported balance sheet, Aeris Resources had liabilities of AU$110.8m due within 12 months, and liabilities of AU$79.6m due beyond 12 months. On the other hand, it had cash of AU$103.5m and AU$12.3m worth of receivables due within a year. So it has liabilities totalling AU$74.6m more than its cash and near-term receivables, combined.
Since publicly traded Aeris Resources shares are worth a total of AU$412.5m, it seems unlikely that this level of liabilities would be a major threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. While it does have liabilities worth noting, Aeris Resources also has more cash than debt, so we're pretty confident it can manage its debt safely.
Although Aeris Resources made a loss at the EBIT level, last year, it was also good to see that it generated AU$77m in EBIT over the last twelve months. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Aeris Resources can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Aeris Resources may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Over the last year, Aeris Resources actually produced more free cash flow than EBIT. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.
Although Aeris Resources's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of AU$76.1m. The cherry on top was that in converted 106% of that EBIT to free cash flow, bringing in AU$82m. So we don't have any problem with Aeris Resources's use of debt. 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. For instance, we've identified 2 warning signs for Aeris Resources that you should be aware of.
Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.
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.
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