Is Lucapa Diamond (ASX:LOM) A Risky Investment?

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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. We can see that Lucapa Diamond Company Limited (ASX:LOM) 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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Lucapa Diamond

What Is Lucapa Diamond's Net Debt?

The image below, which you can click on for greater detail, shows that Lucapa Diamond had debt of US$9.09m at the end of June 2022, a reduction from US$20.7m over a year. However, it does have US$4.54m in cash offsetting this, leading to net debt of about US$4.55m.

A Look At Lucapa Diamond's Liabilities

We can see from the most recent balance sheet that Lucapa Diamond had liabilities of US$14.4m falling due within a year, and liabilities of US$3.83m due beyond that. On the other hand, it had cash of US$4.54m and US$13.5m worth of receivables due within a year. So these liquid assets roughly match the total liabilities.

This state of affairs indicates that Lucapa Diamond's 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 US$59.1m company is struggling for cash, we still think it's worth monitoring its balance sheet. There's no doubt that we learn most about debt from the balance sheet. But it is Lucapa Diamond'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.

Over 12 months, Lucapa Diamond reported revenue of US$23m, which is a gain of 33%, although it did not report any earnings before interest and tax. Shareholders probably have their fingers crossed that it can grow its way to profits.

Caveat Emptor

While we can certainly appreciate Lucapa Diamond's revenue growth, its earnings before interest and tax (EBIT) loss is not ideal. Its EBIT loss was a whopping US$16m. Considering that alongside the liabilities mentioned above does not give us much confidence that company should be using so much debt. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. However, it doesn't help that it burned through US$19m of cash over the last year. So suffice it to say we consider the stock very risky. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. For example Lucapa Diamond has 3 warning signs (and 1 which is concerning) we think you should know about.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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

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.