Is Genesis Resources (ASX:GES) Using Too Much Debt?

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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. As with many other companies Genesis Resources Limited (ASX:GES) makes use of debt. But should shareholders be worried about its use of debt?

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. 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, 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.

See our latest analysis for Genesis Resources

What Is Genesis Resources's Net Debt?

The image below, which you can click on for greater detail, shows that at December 2020 Genesis Resources had debt of AU$7.47m, up from AU$6.40m in one year. Net debt is about the same, since the it doesn't have much cash.

How Healthy Is Genesis Resources' Balance Sheet?

We can see from the most recent balance sheet that Genesis Resources had liabilities of AU$9.90m falling due within a year, and liabilities of AU$6.0k due beyond that. Offsetting these obligations, it had cash of AU$70.0k as well as receivables valued at AU$12.6k due within 12 months. So its liabilities total AU$9.83m more than the combination of its cash and short-term receivables.

Given this deficit is actually higher than the company's market capitalization of AU$8.61m, we think shareholders really should watch Genesis Resources's debt levels, like a parent watching their child ride a bike for the first time. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price. When analysing debt levels, the balance sheet is the obvious place to start. But it is Genesis Resources's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Given its lack of meaningful operating revenue, investors are probably hoping that Genesis Resources finds some valuable resources, before it runs out of money.

Caveat Emptor

Over the last twelve months Genesis Resources produced an earnings before interest and tax (EBIT) loss. Its EBIT loss was a whopping AU$1.1m. Considering that alongside the liabilities mentioned above make us nervous about the company. We'd want to see some strong near-term improvements before getting too interested in the stock. Not least because it had negative free cash flow of AU$1.1m over the last twelve months. So suffice it to say we consider the stock to be risky. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. Be aware that Genesis Resources is showing 4 warning signs in our investment analysis , and 3 of those make us uncomfortable...

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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