Does Allkem (ASX:AKE) Have A Healthy Balance Sheet?

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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 Allkem Limited (ASX:AKE) does use debt in its business. But is this debt a concern to shareholders?

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, 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.

View our latest analysis for Allkem

How Much Debt Does Allkem Carry?

The image below, which you can click on for greater detail, shows that Allkem had debt of US$274.3m at the end of June 2023, a reduction from US$313.1m over a year. However, it does have US$821.4m in cash offsetting this, leading to net cash of US$547.2m.

How Healthy Is Allkem's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Allkem had liabilities of US$445.8m due within 12 months and liabilities of US$1.20b due beyond that. Offsetting these obligations, it had cash of US$821.4m as well as receivables valued at US$142.9m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$679.1m.

Since publicly traded Allkem shares are worth a total of US$5.95b, it seems unlikely that this level of liabilities would be a major threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. While it does have liabilities worth noting, Allkem also has more cash than debt, so we're pretty confident it can manage its debt safely.

In addition to that, we're happy to report that Allkem has boosted its EBIT by 86%, thus reducing the spectre of future debt repayments. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Allkem 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, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Allkem may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. In the last three years, Allkem's free cash flow amounted to 26% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Summing Up

Although Allkem's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of US$547.2m. And we liked the look of last year's 86% year-on-year EBIT growth. So is Allkem's debt a risk? It doesn't seem so to us. Of course, we wouldn't say no to the extra confidence that we'd gain if we knew that Allkem insiders have been buying shares: if you're on the same wavelength, you can find out if insiders are buying by clicking this link.

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.