Is Whitehaven Coal (ASX:WHC) Using Too Much Debt?

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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, Whitehaven Coal Limited (ASX:WHC) does carry 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 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Whitehaven Coal

What Is Whitehaven Coal's Net Debt?

As you can see below, Whitehaven Coal had AU$39.1m of debt at December 2022, down from AU$356.0m a year prior. But on the other hand it also has AU$2.63b in cash, leading to a AU$2.59b net cash position.

How Healthy Is Whitehaven Coal's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Whitehaven Coal had liabilities of AU$1.77b due within 12 months and liabilities of AU$887.9m due beyond that. On the other hand, it had cash of AU$2.63b and AU$724.1m worth of receivables due within a year. So it actually has AU$690.9m more liquid assets than total liabilities.

This surplus suggests that Whitehaven Coal has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Whitehaven Coal has more cash than debt is arguably a good indication that it can manage its debt safely.

Better yet, Whitehaven Coal grew its EBIT by 781% last year, which is an impressive improvement. If maintained that growth will make the debt even more manageable in the years ahead. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Whitehaven Coal can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Whitehaven Coal has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Over the last two years, Whitehaven Coal recorded free cash flow worth a fulsome 90% of its EBIT, which is stronger than we'd usually expect. That positions it well to pay down debt if desirable to do so.

Summing Up

While it is always sensible to investigate a company's debt, in this case Whitehaven Coal has AU$2.59b in net cash and a decent-looking balance sheet. The cherry on top was that in converted 90% of that EBIT to free cash flow, bringing in AU$4.3b. So we don't think Whitehaven Coal's use of debt is risky. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. Be aware that Whitehaven Coal is showing 2 warning signs in our investment analysis , and 1 of those is concerning...

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.