Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk'. 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. Importantly, Orocobre Limited (ASX:ORE) does carry debt. But the real question is whether this debt is making the company risky.
What Risk Does Debt Bring?
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. If things get really bad, the lenders can take control of the business. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.
What Is Orocobre's Debt?
You can click the graphic below for the historical numbers, but it shows that as of June 2019 Orocobre had US$187.5m of debt, an increase on US$0.7, over one year. However, it does have US$279.8m in cash offsetting this, leading to net cash of US$92.3m.
A Look At Orocobre's Liabilities
Zooming in on the latest balance sheet data, we can see that Orocobre had liabilities of US$110.9m due within 12 months and liabilities of US$267.4m due beyond that. Offsetting this, it had US$279.8m in cash and US$22.5m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$76.0m.
Of course, Orocobre has a market capitalization of US$472.4m, so these liabilities are probably manageable. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. Despite its noteworthy liabilities, Orocobre boasts net cash, so it's fair to say it does not have a heavy debt load!
Although Orocobre made a loss at the EBIT level, last year, it was also good to see that it generated US$4.3m in EBIT over the last twelve months. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Orocobre 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.
Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While Orocobre 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. Over the last year, Orocobre saw substantial negative free cash flow, in total. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.
While Orocobre does have more liabilities than liquid assets, it also has net cash of US$92.3m. So we are not troubled with Orocobre's debt use. We'd be motivated to research the stock further if we found out that Orocobre insiders have bought shares recently. If you would too, then you're in luck, since today we're sharing our list of reported insider transactions for free.
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.
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