These 4 Measures Indicate That Alkane Resources (ASX:ALK) Is Using Debt Reasonably Well

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.' 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. Importantly, Alkane Resources Limited (ASX:ALK) does carry debt. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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.

See our latest analysis for Alkane Resources

What Is Alkane Resources's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of December 2020 Alkane Resources had AU$8.94m of debt, an increase on none, over one year. However, its balance sheet shows it holds AU$33.3m in cash, so it actually has AU$24.4m net cash.

A Look At Alkane Resources' Liabilities

Zooming in on the latest balance sheet data, we can see that Alkane Resources had liabilities of AU$18.5m due within 12 months and liabilities of AU$20.2m due beyond that. Offsetting this, it had AU$33.3m in cash and AU$3.15m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by AU$2.15m.

This state of affairs indicates that Alkane Resources' 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$416.8m 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.

On top of that, Alkane Resources grew its EBIT by 52% over the last twelve months, and that growth will make it easier to handle its debt. 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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. 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. Over the last three years, Alkane Resources recorded negative free cash flow, in total. Debt is usually more expensive, and almost always more risky in the hands of a company with negative free cash flow. Shareholders ought to hope for an improvement.

Summing up

While it is always sensible to look at a company's total liabilities, it is very reassuring that Alkane Resources has AU$24.4m in net cash. And we liked the look of last year's 52% year-on-year EBIT growth. So we are not troubled with Alkane Resources's debt use. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. Be aware that Alkane Resources is showing 3 warning signs in our investment analysis , and 1 of those can't be ignored...

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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