Pilbara Minerals (ASX:PLS) Seems To Use Debt Rather Sparingly

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' 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. We note that Pilbara Minerals Limited (ASX:PLS) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. 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, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Pilbara Minerals

How Much Debt Does Pilbara Minerals Carry?

As you can see below, at the end of June 2023, Pilbara Minerals had AU$332.9m of debt, up from AU$234.7m a year ago. Click the image for more detail. However, it does have AU$3.34b in cash offsetting this, leading to net cash of AU$3.01b.

A Look At Pilbara Minerals' Liabilities

We can see from the most recent balance sheet that Pilbara Minerals had liabilities of AU$1.29b falling due within a year, and liabilities of AU$514.7m due beyond that. On the other hand, it had cash of AU$3.34b and AU$123.9m worth of receivables due within a year. So it actually has AU$1.65b 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.

Better yet, Pilbara Minerals grew its EBIT by 318% last year, which is an impressive improvement. That boost will make it even easier to pay down debt 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 want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. 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 two years, Pilbara Minerals generated free cash flow amounting to a very robust 90% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.

Summing Up

While it is always sensible to investigate a company's debt, in this case Pilbara Minerals has AU$3.01b in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of AU$3.1b, being 90% of its EBIT. So we don't think Pilbara Minerals's use of debt is risky. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that Pilbara Minerals is showing 2 warning signs in our investment analysis , and 1 of those is significant...

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. 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.