Here's Why Champion Iron (ASX:CIA) Can Manage Its Debt Responsibly

Warren Buffett famously said, '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. As with many other companies Champion Iron Limited (ASX:CIA) makes use of debt. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

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 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Champion Iron

What Is Champion Iron's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of December 2021 Champion Iron had CA$302.7m of debt, an increase on CA$242.4m, over one year. However, its balance sheet shows it holds CA$499.0m in cash, so it actually has CA$196.3m net cash.

How Strong Is Champion Iron's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Champion Iron had liabilities of CA$332.4m due within 12 months and liabilities of CA$495.3m due beyond that. On the other hand, it had cash of CA$499.0m and CA$65.0m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by CA$263.7m.

Given Champion Iron has a market capitalization of CA$3.17b, it's hard to believe these liabilities pose much threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. While it does have liabilities worth noting, Champion Iron also has more cash than debt, so we're pretty confident it can manage its debt safely.

On top of that, Champion Iron grew its EBIT by 69% over the last twelve months, and that growth will make it easier to handle its debt. 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're focused on the future you can check out this free report showing analyst profit forecasts.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs 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. In the last three years, Champion Iron's free cash flow amounted to 36% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Summing up

While it is always sensible to look at a company's total liabilities, it is very reassuring that Champion Iron has CA$196.3m in net cash. And we liked the look of last year's 69% year-on-year EBIT growth. So is Champion Iron's debt a risk? It doesn't seem so to us. 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 example Champion Iron has 5 warning signs (and 2 which are significant) we think you should know about.

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. 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.