Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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. Importantly, Lynas Rare Earths Limited (ASX:LYC) does carry debt. But the real question is whether this debt is making the company risky.
When Is Debt Dangerous?
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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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.
What Is Lynas Rare Earths's Net Debt?
As you can see below, at the end of December 2021, Lynas Rare Earths had AU$177.3m of debt, up from AU$163.7m a year ago. Click the image for more detail. But it also has AU$674.2m in cash to offset that, meaning it has AU$496.9m net cash.
How Healthy Is Lynas Rare Earths' Balance Sheet?
The latest balance sheet data shows that Lynas Rare Earths had liabilities of AU$121.4m due within a year, and liabilities of AU$271.0m falling due after that. On the other hand, it had cash of AU$674.2m and AU$102.2m worth of receivables due within a year. So it can boast AU$384.0m more liquid assets than total liabilities.
This surplus suggests that Lynas Rare Earths has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, Lynas Rare Earths boasts net cash, so it's fair to say it does not have a heavy debt load!
Even more impressive was the fact that Lynas Rare Earths grew its EBIT by 1,762% over twelve months. That boost will make it even easier to pay down debt going forward. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Lynas Rare Earths'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.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Lynas Rare Earths 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. During the last three years, Lynas Rare Earths produced sturdy free cash flow equating to 73% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.
While it is always sensible to investigate a company's debt, in this case Lynas Rare Earths has AU$496.9m in net cash and a decent-looking balance sheet. And we liked the look of last year's 1,762% year-on-year EBIT growth. So we don't think Lynas Rare Earths's use of debt is 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, we've discovered 1 warning sign for Lynas Rare Earths that you should be aware of before investing here.
Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.
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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.
Lynas Rare Earths
Lynas Rare Earths Limited, together with its subsidiaries, engages in the exploration, development, mining, extraction, and processing of rare earth minerals primarily in Australia and Malaysia.
Flawless balance sheet with solid track record.