Is Emerald Resources (ASX:EMR) A Risky Investment?

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. We can see that Emerald Resources NL (ASX:EMR) does use debt in its business. But is this debt a concern to shareholders?

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. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Emerald Resources

What Is Emerald Resources's Debt?

As you can see below, Emerald Resources had AU$62.0m of debt at December 2023, down from AU$82.9m a year prior. But on the other hand it also has AU$116.0m in cash, leading to a AU$54.0m net cash position.

How Healthy Is Emerald Resources' Balance Sheet?

We can see from the most recent balance sheet that Emerald Resources had liabilities of AU$122.3m falling due within a year, and liabilities of AU$47.9m due beyond that. Offsetting this, it had AU$116.0m in cash and AU$13.8m in receivables that were due within 12 months. So it has liabilities totalling AU$40.4m more than its cash and near-term receivables, combined.

This state of affairs indicates that Emerald 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$2.24b company is struggling for cash, we still think it's worth monitoring its balance sheet. While it does have liabilities worth noting, Emerald Resources also has more cash than debt, so we're pretty confident it can manage its debt safely.

On top of that, Emerald Resources grew its EBIT by 41% 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 Emerald Resources'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. Emerald Resources 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. Over the most recent three years, Emerald Resources recorded free cash flow worth 60% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Summing Up

While it is always sensible to look at a company's total liabilities, it is very reassuring that Emerald Resources has AU$54.0m in net cash. And we liked the look of last year's 41% year-on-year EBIT growth. So is Emerald Resources'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. We've identified 1 warning sign with Emerald Resources , and understanding them should be part of your investment process.

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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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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com