The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says '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. As with many other companies Pilbara Minerals Limited (ASX:PLS) makes use of debt. But the real question is whether this debt is making the company risky.
What Risk Does Debt Bring?
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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.
What Is Pilbara Minerals's Net Debt?
The chart below, which you can click on for greater detail, shows that Pilbara Minerals had AU$134.2m in debt in June 2020; about the same as the year before. However, it also had AU$86.3m in cash, and so its net debt is AU$48.0m.
A Look At Pilbara Minerals's Liabilities
The latest balance sheet data shows that Pilbara Minerals had liabilities of AU$75.4m due within a year, and liabilities of AU$140.1m falling due after that. On the other hand, it had cash of AU$86.3m and AU$2.90m worth of receivables due within a year. So it has liabilities totalling AU$126.3m more than its cash and near-term receivables, combined.
Since publicly traded Pilbara Minerals shares are worth a total of AU$767.5m, it seems unlikely that this level of liabilities would be a major threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. 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 Pilbara Minerals'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.
In the last year Pilbara Minerals wasn't profitable at an EBIT level, but managed to grow its revenue by 96%, to AU$84m. Shareholders probably have their fingers crossed that it can grow its way to profits.
While we can certainly appreciate Pilbara Minerals's revenue growth, its earnings before interest and tax (EBIT) loss is not ideal. Indeed, it lost AU$56.4m at the EBIT level. Considering that alongside the liabilities mentioned above does not give us much confidence that company should be using so much debt. So we think its balance sheet is a little strained, though not beyond repair. However, it doesn't help that it burned through AU$41.6m of cash over the last year. So in short it's a really risky stock. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. To that end, you should be aware of the 2 warning signs we've spotted with Pilbara Minerals .
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. 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.
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