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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. Importantly, Northern Star Resources Limited (ASX:NST) does carry debt. But is this debt a concern to shareholders?
Why Does Debt Bring Risk?
Generally speaking, debt only becomes a real problem when a company can’t easily pay it off, either by raising capital or with its own cash flow. If things get really bad, the lenders can take control of the business. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
What Is Northern Star Resources’s Debt?
As you can see below, at the end of December 2018, Northern Star Resources had AU$41.6m of debt, up from AU$12.4m a year ago. Click the image for more detail. However, it does have AU$229.8m in cash offsetting this, leading to net cash of AU$188.3m.
How Strong Is Northern Star Resources’s Balance Sheet?
We can see from the most recent balance sheet that Northern Star Resources had liabilities of AU$218.7m falling due within a year, and liabilities of AU$332.6m due beyond that. Offsetting these obligations, it had cash of AU$229.8m as well as receivables valued at AU$46.2m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by AU$275.2m.
Given Northern Star Resources has a market capitalization of AU$7.60b, it’s hard to believe these liabilities pose much threat. Having said that, it’s clear that we should continue to monitor its balance sheet, lest it change for the worse. Northern Star Resources boasts net cash, so it’s fair to say it does not have a heavy debt load!
Also good is that Northern Star Resources grew its EBIT at 13% over the last year, further increasing its ability to manage debt. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Northern Star Resources 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Northern Star Resources 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 most recent three years, Northern Star Resources recorded free cash flow worth 52% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.
We could understand if investors are concerned about Northern Star Resources’s liabilities, but we can be reassured by the fact it has has net cash of AU$188m. On top of that, it increased its EBIT by 13% in the last twelve months. So we don’t think Northern Star Resources’s use of debt is risky. We’d be motivated to research the stock further if we found out that Northern Star Resources insiders have bought shares recently. If you would too, then you’re in luck, since today we’re sharing our list of reported insider transactions for free.
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.
We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.
If you spot an error that warrants correction, please contact the editor at email@example.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.