Here's Why Audalia Resources (ASX:ACP) Can Afford Some Debt

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 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 note that Audalia Resources Limited (ASX:ACP) does have debt on its balance sheet. But is this debt a concern to shareholders?

When Is Debt A Problem?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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.

Check out our latest analysis for Audalia Resources

What Is Audalia Resources's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of December 2023 Audalia Resources had AU$5.34m of debt, an increase on AU$5.09m, over one year. Net debt is about the same, since the it doesn't have much cash.

A Look At Audalia Resources' Liabilities

According to the last reported balance sheet, Audalia Resources had liabilities of AU$1.25m due within 12 months, and liabilities of AU$8.27m due beyond 12 months. Offsetting these obligations, it had cash of AU$11.1k as well as receivables valued at AU$46.0k due within 12 months. So it has liabilities totalling AU$9.46m more than its cash and near-term receivables, combined.

This deficit is considerable relative to its market capitalization of AU$15.2m, so it does suggest shareholders should keep an eye on Audalia Resources' use of debt. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Audalia 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.

Since Audalia Resources has no significant operating revenue, shareholders probably hope it will develop a valuable new mine before too long.

Caveat Emptor

Over the last twelve months Audalia Resources produced an earnings before interest and tax (EBIT) loss. Indeed, it lost AU$387k 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. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. However, it doesn't help that it burned through AU$775k of cash over the last year. So suffice it to say we consider the stock very risky. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. We've identified 5 warning signs with Audalia Resources (at least 4 which make us uncomfortable) , and understanding them should be part of your investment process.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.