Does Rey Resources (ASX:REY) Have A Healthy Balance Sheet?

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.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We can see that Rey Resources Limited (ASX:REY) does use debt in its business. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. 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.

View our latest analysis for Rey Resources

How Much Debt Does Rey Resources Carry?

As you can see below, at the end of December 2021, Rey Resources had AU$11.7m of debt, up from AU$9.04m a year ago. Click the image for more detail. Net debt is about the same, since the it doesn't have much cash.

How Strong Is Rey Resources' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Rey Resources had liabilities of AU$11.8m due within 12 months and liabilities of AU$3.32m due beyond that. Offsetting these obligations, it had cash of AU$85.0k as well as receivables valued at AU$77.0k due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by AU$15.0m.

While this might seem like a lot, it is not so bad since Rey Resources has a market capitalization of AU$33.9m, and so it could probably strengthen its balance sheet by raising capital if it needed to. However, it is still worthwhile taking a close look at its ability to pay off debt. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Rey Resources will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Given its lack of meaningful operating revenue, Rey Resources shareholders no doubt hope it can fund itself until it can sell some combustibles.

Caveat Emptor

Importantly, Rey Resources had an earnings before interest and tax (EBIT) loss over the last year. Indeed, it lost AU$444k 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$1.1m in negative free cash flow over the last twelve months. So suffice it to say we do consider the stock to be risky. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. For example Rey Resources has 4 warning signs (and 3 which are significant) we think you should know about.

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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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.