Here's Why Lynas Rare Earths (ASX:LYC) Has A Meaningful Debt Burden

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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 Lynas Rare Earths Limited (ASX:LYC) does have debt on its balance sheet. But is this debt a concern to shareholders?

When Is Debt Dangerous?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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.

Check out our latest analysis for Lynas Rare Earths

How Much Debt Does Lynas Rare Earths Carry?

You can click the graphic below for the historical numbers, but it shows that Lynas Rare Earths had AU$172.6m of debt in December 2023, down from AU$188.4m, one year before. But on the other hand it also has AU$686.1m in cash, leading to a AU$513.5m net cash position.

How Strong Is Lynas Rare Earths' Balance Sheet?

According to the last reported balance sheet, Lynas Rare Earths had liabilities of AU$142.4m due within 12 months, and liabilities of AU$381.3m due beyond 12 months. Offsetting this, it had AU$686.1m in cash and AU$42.2m in receivables that were due within 12 months. So it can boast AU$204.6m more liquid assets than total liabilities.

This short term liquidity is a sign that Lynas Rare Earths could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, Lynas Rare Earths boasts net cash, so it's fair to say it does not have a heavy debt load!

In fact Lynas Rare Earths's saving grace is its low debt levels, because its EBIT has tanked 69% in the last twelve months. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Lynas Rare Earths can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While Lynas Rare Earths 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 three years, Lynas Rare Earths recorded negative free cash flow, in total. Debt is usually more expensive, and almost always more risky in the hands of a company with negative free cash flow. Shareholders ought to hope for an improvement.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Lynas Rare Earths has net cash of AU$513.5m, as well as more liquid assets than liabilities. So although we see some areas for improvement, we're not too worried about Lynas Rare Earths's balance sheet. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should learn about the 3 warning signs we've spotted with Lynas Rare Earths (including 1 which is potentially serious) .

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.

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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.