Is Kingston Resources (ASX:KSN) Using Too Much Debt?

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We note that Kingston Resources Limited (ASX:KSN) does have debt on its balance sheet. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

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, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Kingston Resources

How Much Debt Does Kingston Resources Carry?

As you can see below, at the end of December 2022, Kingston Resources had AU$4.88m of debt, up from AU$95.3k a year ago. Click the image for more detail. However, its balance sheet shows it holds AU$7.27m in cash, so it actually has AU$2.39m net cash.

How Strong Is Kingston Resources' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Kingston Resources had liabilities of AU$13.0m due within 12 months and liabilities of AU$17.1m due beyond that. Offsetting these obligations, it had cash of AU$7.27m as well as receivables valued at AU$1.21m due within 12 months. So its liabilities total AU$21.7m more than the combination of its cash and short-term receivables.

This deficit is considerable relative to its market capitalization of AU$34.5m, so it does suggest shareholders should keep an eye on Kingston Resources' use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution. 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. 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 when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

In the last year Kingston Resources managed to produce its first revenue as a listed company, but given the lack of profit, shareholders will no doubt be hoping to see some strong increases.

So How Risky Is Kingston Resources?

By their very nature companies that are losing money are more risky than those with a long history of profitability. And in the last year Kingston Resources had an earnings before interest and tax (EBIT) loss, truth be told. Indeed, in that time it burnt through AU$12m of cash and made a loss of AU$1.3m. Given it only has net cash of AU$2.39m, the company may need to raise more capital if it doesn't reach break-even soon. Overall, we'd say the stock is a bit risky, and we're usually very cautious until we see positive free cash flow. 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. Be aware that Kingston Resources is showing 3 warning signs in our investment analysis , and 1 of those makes us a bit 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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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.