Health Check: How Prudently Does Admiralty Resources (ASX:ADY) Use 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.' 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. We can see that Admiralty Resources NL (ASX:ADY) does use debt in its business. But is this debt a concern to shareholders?

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. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Admiralty Resources

What Is Admiralty Resources's Net Debt?

As you can see below, at the end of June 2024, Admiralty Resources had AU$16.0m of debt, up from AU$14.6m a year ago. Click the image for more detail. Net debt is about the same, since the it doesn't have much cash.

A Look At Admiralty Resources' Liabilities

Zooming in on the latest balance sheet data, we can see that Admiralty Resources had liabilities of AU$2.61m due within 12 months and liabilities of AU$14.0m due beyond that. Offsetting this, it had AU$110.2k in cash and AU$52.9k in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by AU$16.4m.

Given this deficit is actually higher than the company's market capitalization of AU$11.4m, we think shareholders really should watch Admiralty Resources's debt levels, like a parent watching their child ride a bike for the first time. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price. When analysing debt levels, the balance sheet is the obvious place to start. But it is Admiralty Resources's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

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

Caveat Emptor

Importantly, Admiralty Resources had an earnings before interest and tax (EBIT) loss over the last year. Indeed, it lost AU$1.1m at the EBIT level. When we look at that alongside the significant liabilities, we're not particularly confident about the company. We'd want to see some strong near-term improvements before getting too interested in the stock. Not least because it had negative free cash flow of AU$1.6m 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. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 6 warning signs for Admiralty Resources you should be aware of, and 4 of them make us uncomfortable.

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.