Is Lynas Rare Earths (ASX:LYC) A Risky Investment?

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.' 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. Importantly, Lynas Rare Earths Limited (ASX:LYC) does carry debt. But the real question is whether this debt is making the company risky.

We've discovered 2 warning signs about Lynas Rare Earths. View them for free.

When Is Debt A Problem?

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. 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.

What Is Lynas Rare Earths's Debt?

The chart below, which you can click on for greater detail, shows that Lynas Rare Earths had AU$171.8m in debt in December 2024; about the same as the year before. But on the other hand it also has AU$308.3m in cash, leading to a AU$136.5m net cash position.

How Healthy Is Lynas Rare Earths' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Lynas Rare Earths had liabilities of AU$142.7m due within 12 months and liabilities of AU$428.2m due beyond that. Offsetting this, it had AU$308.3m in cash and AU$50.0m in receivables that were due within 12 months. So it has liabilities totalling AU$212.6m more than its cash and near-term receivables, combined.

Since publicly traded Lynas Rare Earths shares are worth a total of AU$7.75b, it seems unlikely that this level of liabilities would be a major threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. Despite its noteworthy liabilities, Lynas Rare Earths boasts net cash, so it's fair to say it does not have a heavy debt load!

See our latest analysis for Lynas Rare Earths

It is just as well that Lynas Rare Earths's load is not too heavy, because its EBIT was down 73% over the last year. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. There's no doubt that we learn most about debt from the balance sheet. 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're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. 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. During the last three years, Lynas Rare Earths burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Summing Up

We could understand if investors are concerned about Lynas Rare Earths's liabilities, but we can be reassured by the fact it has has net cash of AU$136.5m. So although we see some areas for improvement, we're not too worried about Lynas Rare Earths's balance sheet. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. To that end, you should learn about the 2 warning signs we've spotted with Lynas Rare Earths (including 1 which is significant) .

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.