Is Northern Star Resources (ASX:NST) Using Debt Sensibly?

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.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We can see that Northern Star Resources Limited (ASX:NST) does use debt in its business. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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 thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for Northern Star Resources

What Is Northern Star Resources's Net Debt?

As you can see below, Northern Star Resources had AU$297.0m of debt at December 2021, down from AU$371.6m a year prior. But it also has AU$528.0m in cash to offset that, meaning it has AU$231.0m net cash.

A Look At Northern Star Resources' Liabilities

According to the last reported balance sheet, Northern Star Resources had liabilities of AU$712.0m due within 12 months, and liabilities of AU$2.32b due beyond 12 months. Offsetting this, it had AU$528.0m in cash and AU$263.0m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by AU$2.24b.

Since publicly traded Northern Star Resources shares are worth a total of AU$12.5b, it seems unlikely that this level of liabilities would be a major threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. While it does have liabilities worth noting, Northern Star Resources also has more cash than debt, so we're pretty confident it can manage its debt safely. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Northern Star Resources'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.

Over 12 months, Northern Star Resources reported revenue of AU$3.5b, which is a gain of 53%, although it did not report any earnings before interest and tax. With any luck the company will be able to grow its way to profitability.

So How Risky Is Northern Star Resources?

While Northern Star Resources lost money on an earnings before interest and tax (EBIT) level, it actually booked a paper profit of AU$1.1b. So taking that on face value, and considering the cash, we don't think its very risky in the near term. The good news for Northern Star Resources shareholders is that its revenue growth is strong, making it easier to raise capital if need be. But we still think it's somewhat risky. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should be aware of the 1 warning sign we've spotted with Northern Star Resources .

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.