We Think Northern Star Resources (ASX:NST) Can Stay On Top Of Its Debt

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. 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?

What Risk Does Debt Bring?

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. 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, 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.

View 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 December 2022 Northern Star Resources had debt of AU$348.0m, up from AU$297.0m in one year. But it also has AU$409.5m in cash to offset that, meaning it has AU$61.5m net cash.

A Look At Northern Star Resources' Liabilities

According to the last reported balance sheet, Northern Star Resources had liabilities of AU$607.6m due within 12 months, and liabilities of AU$2.44b due beyond 12 months. Offsetting this, it had AU$409.5m in cash and AU$170.3m in receivables that were due within 12 months. So it has liabilities totalling AU$2.47b more than its cash and near-term receivables, combined.

Given Northern Star Resources has a market capitalization of AU$12.5b, 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. Despite its noteworthy liabilities, Northern Star Resources boasts net cash, so it's fair to say it does not have a heavy debt load!

It was also good to see that despite losing money on the EBIT line last year, Northern Star Resources turned things around in the last 12 months, delivering and EBIT of AU$215m. 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 company can only pay off debt with cold hard cash, not accounting profits. Northern Star Resources may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Over the last year, Northern Star Resources actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Summing Up

While Northern Star Resources does have more liabilities than liquid assets, it also has net cash of AU$61.5m. The cherry on top was that in converted 149% of that EBIT to free cash flow, bringing in AU$319m. So we don't think Northern Star Resources's use of debt is risky. 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. For instance, we've identified 2 warning signs for Northern Star Resources that you should be aware of.

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.