Is Rey Resources (ASX:REY) Using Debt Sensibly?

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. Importantly, Rey Resources Limited (ASX:REY) does carry debt. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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 step when considering a company's debt levels is to consider its cash and debt 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 2022, Rey Resources had AU$14.3m of debt, up from AU$11.7m a year ago. Click the image for more detail. And it doesn't have much cash, so its net debt is about the same.

A Look At Rey Resources' Liabilities

We can see from the most recent balance sheet that Rey Resources had liabilities of AU$14.8m falling due within a year, and liabilities of AU$3.65m due beyond that. On the other hand, it had cash of AU$101.0k and AU$3.0k worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by AU$18.3m.

This is a mountain of leverage relative to its market capitalization of AU$21.2m. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution. When analysing debt levels, the balance sheet is the obvious place to start. But it is Rey Resources'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.

Since Rey Resources doesn't have significant operating revenue, shareholders must hope it'll sell some fossil fuels, before it runs out of money.

Caveat Emptor

Over the last twelve months Rey Resources produced an earnings before interest and tax (EBIT) loss. Indeed, it lost AU$468k at the EBIT level. Considering that alongside the liabilities mentioned above does not give us much confidence that company should be using so much debt. So we think its balance sheet is a little strained, though not beyond repair. However, it doesn't help that it burned through AU$1.4m of cash over the last year. So suffice it to say we consider the stock very risky. 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. For example, we've discovered 4 warning signs for Rey Resources (3 don't sit too well with us!) that you should be aware of before investing here.

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.