Pilbara Minerals (ASX:PLS) Has A Pretty Healthy Balance Sheet

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 is this debt a concern to shareholders?

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. 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, 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.

View our latest analysis for Pilbara Minerals

What Is Pilbara Minerals's Debt?

You can click the graphic below for the historical numbers, but it shows that as of June 2024 Pilbara Minerals had AU$446.9m of debt, an increase on AU$332.9m, over one year. But it also has AU$1.63b in cash to offset that, meaning it has AU$1.18b net cash.

A Look At Pilbara Minerals' Liabilities

According to the last reported balance sheet, Pilbara Minerals had liabilities of AU$430.5m due within 12 months, and liabilities of AU$634.6m due beyond 12 months. Offsetting this, it had AU$1.63b in cash and AU$175.4m in receivables that were due within 12 months. So it actually has AU$736.8m more liquid assets than total liabilities.

This surplus suggests that Pilbara Minerals has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Pilbara Minerals has more cash than debt is arguably a good indication that it can manage its debt safely.

The modesty of its debt load may become crucial for Pilbara Minerals if management cannot prevent a repeat of the 88% cut to EBIT over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. 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. While Pilbara Minerals has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. During the last three years, Pilbara Minerals produced sturdy free cash flow equating to 53% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Pilbara Minerals has net cash of AU$1.18b, as well as more liquid assets than liabilities. So we don't have any problem with Pilbara Minerals's use of debt. 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. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for Pilbara Minerals (of which 1 doesn't sit too well with us!) 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.