Champion Iron (ASX:CIA) Has A Rock Solid 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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We note that Champion Iron Limited (ASX:CIA) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

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 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Champion Iron

What Is Champion Iron's Net Debt?

As you can see below, at the end of December 2020, Champion Iron had CA$242.4m of debt, up from CA$225.8m a year ago. Click the image for more detail. However, its balance sheet shows it holds CA$507.2m in cash, so it actually has CA$264.8m net cash.

How Strong Is Champion Iron's Balance Sheet?

According to the last reported balance sheet, Champion Iron had liabilities of CA$205.4m due within 12 months, and liabilities of CA$375.4m due beyond 12 months. On the other hand, it had cash of CA$507.2m and CA$71.2m worth of receivables due within a year. So these liquid assets roughly match the total liabilities.

This state of affairs indicates that Champion Iron's balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So it's very unlikely that the CA$2.86b company is short on cash, but still worth keeping an eye on the balance sheet. Despite its noteworthy liabilities, Champion Iron boasts net cash, so it's fair to say it does not have a heavy debt load!

In addition to that, we're happy to report that Champion Iron has boosted its EBIT by 60%, thus reducing the spectre of future debt repayments. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Champion Iron's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Champion Iron 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. Looking at the most recent three years, Champion Iron recorded free cash flow of 40% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

Summing up

We could understand if investors are concerned about Champion Iron's liabilities, but we can be reassured by the fact it has has net cash of CA$264.8m. And we liked the look of last year's 60% year-on-year EBIT growth. So we don't think Champion Iron's use of debt is risky. 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 Champion Iron is showing 2 warning signs in our investment analysis , and 1 of those is potentially serious...

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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This article by Simply Wall St is general in nature. 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.
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