Here's Why Kingston Resources (ASX:KSN) Can Manage Its Debt Responsibly

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.' 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. We can see that Kingston Resources Limited (ASX:KSN) does use debt in its business. But the real question is whether this debt is making the company risky.

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Kingston Resources

What Is Kingston Resources's Net Debt?

The image below, which you can click on for greater detail, shows that at December 2023 Kingston Resources had debt of AU$9.67m, up from AU$4.88m in one year. However, it does have AU$10.9m in cash offsetting this, leading to net cash of AU$1.20m.

How Strong Is Kingston Resources' Balance Sheet?

We can see from the most recent balance sheet that Kingston Resources had liabilities of AU$16.1m falling due within a year, and liabilities of AU$16.6m due beyond that. Offsetting these obligations, it had cash of AU$10.9m as well as receivables valued at AU$522.7k due within 12 months. So its liabilities total AU$21.3m more than the combination of its cash and short-term receivables.

While this might seem like a lot, it is not so bad since Kingston Resources has a market capitalization of AU$44.8m, and so it could probably strengthen its balance sheet by raising capital if it needed to. However, it is still worthwhile taking a close look at its ability to pay off debt. While it does have liabilities worth noting, Kingston Resources also has more cash than debt, so we're pretty confident it can manage its debt safely.

Although Kingston Resources made a loss at the EBIT level, last year, it was also good to see that it generated AU$13m in EBIT over the last twelve months. When analysing debt levels, the balance sheet is the obvious place to start. But it is Kingston Resources's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. While Kingston 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 year, Kingston Resources reported free cash flow worth 19% of its EBIT, which is really quite low. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.

Summing Up

While Kingston Resources does have more liabilities than liquid assets, it also has net cash of AU$1.20m. So we don't have any problem with Kingston Resources's use of debt. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 2 warning signs for Kingston Resources that you should be aware of before investing here.

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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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.