Northern Star Resources (ASX:NST) Could Easily Take On More Debt

Warren Buffett famously said, '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. As with many other companies Northern Star Resources Limited (ASX:NST) makes use of debt. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

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. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Northern Star Resources

What Is Northern Star Resources's Debt?

The image below, which you can click on for greater detail, shows that at June 2023 Northern Star Resources had debt of AU$1.18b, up from AU$97.5m in one year. However, because it has a cash reserve of AU$1.13b, its net debt is less, at about AU$42.2m.

How Strong Is Northern Star Resources' Balance Sheet?

We can see from the most recent balance sheet that Northern Star Resources had liabilities of AU$626.1m falling due within a year, and liabilities of AU$3.21b due beyond that. On the other hand, it had cash of AU$1.13b and AU$218.3m worth of receivables due within a year. So its liabilities total AU$2.48b more than the combination of its cash and short-term receivables.

Of course, Northern Star Resources has a market capitalization of AU$12.9b, so these liabilities are probably manageable. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. Carrying virtually no net debt, Northern Star Resources has a very light debt load indeed.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Northern Star Resources has very little debt (net of cash), and boasts a debt to EBITDA ratio of 0.021 and EBIT of 14.0 times the interest expense. So relative to past earnings, the debt load seems trivial. Better yet, Northern Star Resources grew its EBIT by 171% last year, which is an impressive improvement. 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 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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So it's worth checking how much of that EBIT is backed by free cash flow. Over the most recent two years, Northern Star Resources recorded free cash flow worth 69% 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.

Our View

The good news is that Northern Star Resources's demonstrated ability to cover its interest expense with its EBIT delights us like a fluffy puppy does a toddler. And the good news does not stop there, as its EBIT growth rate also supports that impression! Overall, we don't think Northern Star Resources is taking any bad risks, as its debt load seems modest. So the balance sheet looks pretty healthy, to us. We'd be very excited to see if Northern Star Resources insiders have been snapping up shares. If you are too, then click on this link right now to take a (free) peek at our list of reported insider transactions.

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.

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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.