Here's Why Alkane Resources (ASX:ALK) Can Manage Its Debt Responsibly

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. As with many other companies Alkane Resources Limited (ASX:ALK) makes use of debt. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

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. If things get really bad, the lenders can take control of the business. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Alkane Resources

How Much Debt Does Alkane Resources Carry?

The image below, which you can click on for greater detail, shows that at June 2020 Alkane Resources had debt of AU$6.61m, up from none in one year. But it also has AU$48.3m in cash to offset that, meaning it has AU$41.7m net cash.

How Healthy Is Alkane Resources's Balance Sheet?

According to the last reported balance sheet, Alkane Resources had liabilities of AU$40.8m due within 12 months, and liabilities of AU$19.5m due beyond 12 months. Offsetting this, it had AU$48.3m in cash and AU$2.02m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by AU$9.97m.

This state of affairs indicates that Alkane Resources's balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So while it's hard to imagine that the AU$577.4m company is struggling for cash, we still think it's worth monitoring its balance sheet. While it does have liabilities worth noting, Alkane Resources also has more cash than debt, so we're pretty confident it can manage its debt safely.

But the bad news is that Alkane Resources has seen its EBIT plunge 17% in the last twelve months. If that rate of decline in earnings continues, the company could find itself in a tight spot. 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 Alkane Resources can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Alkane Resources 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. In the last three years, Alkane Resources basically broke even on a free cash flow basis. Some might say that's a concern, when it comes considering how easily it would be for it to down debt.

Summing up

We could understand if investors are concerned about Alkane Resources's liabilities, but we can be reassured by the fact it has has net cash of AU$41.7m. So we don't have any problem with Alkane Resources's use of debt. 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. For instance, we've identified 3 warning signs for Alkane Resources (1 is a bit unpleasant) you should be aware of.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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