Pilbara Minerals (ASX:PLS) Could Easily Take On More Debt

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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. Importantly, Pilbara Minerals Limited (ASX:PLS) does carry debt. But should shareholders be worried about its use of debt?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth 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 Pilbara Minerals

What Is Pilbara Minerals's Debt?

As you can see below, at the end of December 2022, Pilbara Minerals had AU$224.8m of debt, up from AU$171.3m a year ago. Click the image for more detail. However, it does have AU$2.23b in cash offsetting this, leading to net cash of AU$2.00b.

How Strong Is Pilbara Minerals' Balance Sheet?

According to the last reported balance sheet, Pilbara Minerals had liabilities of AU$870.8m due within 12 months, and liabilities of AU$369.1m due beyond 12 months. On the other hand, it had cash of AU$2.23b and AU$297.2m worth of receivables due within a year. So it can boast AU$1.28b more liquid assets than total liabilities.

This short term liquidity is a sign that Pilbara Minerals could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that Pilbara Minerals has more cash than debt is arguably a good indication that it can manage its debt safely.

Even more impressive was the fact that Pilbara Minerals grew its EBIT by 1,625% over twelve months. If maintained that growth will make the debt even more manageable in the years ahead. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Pilbara Minerals can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Pilbara Minerals 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. During the last two years, Pilbara Minerals generated free cash flow amounting to a very robust 86% of its EBIT, more than we'd expect. That positions it well to pay down debt if desirable to do so.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Pilbara Minerals has net cash of AU$2.00b, as well as more liquid assets than liabilities. And it impressed us with free cash flow of AU$2.1b, being 86% of its EBIT. So we don't think Pilbara Minerals's use of debt is risky. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for Pilbara Minerals (of which 1 is significant!) you should know about.

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.