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. When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We note that Resource Generation Limited (ASX:RES) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.
When Is Debt Dangerous?
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. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.
What Is Resource Generation’s Net Debt?
You can click the graphic below for the historical numbers, but it shows that as of June 2019 Resource Generation had AU$87.2m of debt, an increase on AU$64.1m, over one year. Net debt is about the same, since the it doesn’t have much cash.
How Strong Is Resource Generation’s Balance Sheet?
According to the last reported balance sheet, Resource Generation had liabilities of AU$25.4m due within 12 months, and liabilities of AU$70.3m due beyond 12 months. Offsetting this, it had AU$1.51m in cash and AU$56.0k in receivables that were due within 12 months. So it has liabilities totalling AU$94.1m more than its cash and near-term receivables, combined.
The deficiency here weighs heavily on the AU$49.4m company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet.” So we definitely think shareholders need to watch this one closely. After all, Resource Generation would likely require a major re-capitalisation if it had to pay its creditors today. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Resource Generation’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.
Given its lack of meaningful operating revenue, Resource Generation shareholders no doubt hope it can fund itself until it can sell some combustibles.
Not only did Resource Generation’s revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). Indeed, it lost AU$4.5m at the EBIT level. Considering that alongside the liabilities mentioned above make us nervous about the company. We’d want to see some strong near-term improvements before getting too interested in the stock. Not least because it had negative free cash flow of AU$11m over the last twelve months. That means it’s on the risky side of things. When we look at a riskier company, we like to check how their profits (or losses) are trending over time. Today, we’re providing readers this interactive graph showing how Resource Generation’s profit, revenue, and operating cashflow have changed over the last few years.
When all is said and done, sometimes its easier to focus on companies that don’t even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.
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