Here's Why High Peak Royalties (ASX:HPR) Can Afford Some 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.' 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. As with many other companies High Peak Royalties Limited (ASX:HPR) makes use of debt. But is this debt a concern to shareholders?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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 High Peak Royalties

How Much Debt Does High Peak Royalties Carry?

You can click the graphic below for the historical numbers, but it shows that High Peak Royalties had AU$1.95m of debt in December 2020, down from AU$2.50m, one year before. However, it also had AU$1.03m in cash, and so its net debt is AU$921.3k.

A Look At High Peak Royalties' Liabilities

The latest balance sheet data shows that High Peak Royalties had liabilities of AU$2.12m due within a year, and liabilities of AU$200.0k falling due after that. Offsetting these obligations, it had cash of AU$1.03m as well as receivables valued at AU$143.5k due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by AU$1.15m.

Given High Peak Royalties has a market capitalization of AU$11.3m, it's hard to believe these liabilities pose much threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. The balance sheet is clearly the area to focus on when you are analysing debt. But it is High Peak Royalties'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 High Peak Royalties doesn't have significant operating revenue, shareholders must hope it'll sell some fossil fuels, before it runs out of money.

Caveat Emptor

While High Peak Royalties's falling revenue is about as heartwarming as a wet blanket, arguably its earnings before interest and tax (EBIT) loss is even less appealing. Indeed, it lost AU$557k at the EBIT level. When we look at that and recall the liabilities on its balance sheet, relative to cash, it seems unwise to us for the company to have any debt. So we think its balance sheet is a little strained, though not beyond repair. Another cause for caution is that is bled AU$463k in negative free cash flow over the last twelve months. So to be blunt we think it is risky. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 3 warning signs for High Peak Royalties (2 are concerning) you should be aware of.

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.

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