Is Rey Resources (ASX:REY) A Risky Investment?

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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, Rey Resources Limited (ASX:REY) does carry debt. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

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. If things get really bad, the lenders can take control of the business. 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. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for Rey Resources

How Much Debt Does Rey Resources Carry?

As you can see below, at the end of December 2023, Rey Resources had AU$18.4m of debt, up from AU$14.3m a year ago. Click the image for more detail. However, it does have AU$532.0k in cash offsetting this, leading to net debt of about AU$17.9m.

How Healthy Is Rey Resources' Balance Sheet?

We can see from the most recent balance sheet that Rey Resources had liabilities of AU$18.6m falling due within a year, and liabilities of AU$3.40m due beyond that. Offsetting these obligations, it had cash of AU$532.0k as well as receivables valued at AU$4.0k due within 12 months. So its liabilities total AU$21.4m more than the combination of its cash and short-term receivables.

When you consider that this deficiency exceeds the company's AU$18.0m market capitalization, you might well be inclined to review the balance sheet intently. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer extensive dilution. When analysing debt levels, the balance sheet is the obvious place to start. 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. To be specific the EBIT loss came in at AU$466k. Considering that alongside the liabilities mentioned above make us nervous about the company. It would need to improve its operations quickly for us to be interested in it. Not least because it had negative free cash flow of AU$1.4m over the last twelve months. That means it's on the risky side of things. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should learn about the 4 warning signs we've spotted with Rey Resources (including 3 which don't sit too well with us) .

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.

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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.