Is Ramelius Resources (ASX:RMS) Using Too Much 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.' 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. We can see that Ramelius Resources Limited (ASX:RMS) does use debt in its business. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

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, 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.

Check out our latest analysis for Ramelius Resources

What Is Ramelius Resources's Debt?

You can click the graphic below for the historical numbers, but it shows that as of December 2020 Ramelius Resources had AU$7.88m of debt, an increase on none, over one year. But on the other hand it also has AU$203.7m in cash, leading to a AU$195.8m net cash position.

How Strong Is Ramelius Resources' Balance Sheet?

The latest balance sheet data shows that Ramelius Resources had liabilities of AU$150.3m due within a year, and liabilities of AU$81.4m falling due after that. On the other hand, it had cash of AU$203.7m and AU$11.5m worth of receivables due within a year. So it has liabilities totalling AU$16.5m more than its cash and near-term receivables, combined.

This state of affairs indicates that Ramelius Resources' balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So while it's hard to imagine that the AU$1.23b company is struggling for cash, we still think it's worth monitoring its balance sheet. Despite its noteworthy liabilities, Ramelius Resources boasts net cash, so it's fair to say it does not have a heavy debt load!

Even more impressive was the fact that Ramelius Resources grew its EBIT by 345% over twelve months. That boost will make it even easier to pay down debt going forward. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Ramelius 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 business needs free cash flow to pay off debt; accounting profits just don't cut it. While Ramelius Resources 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. Over the last three years, Ramelius Resources recorded free cash flow worth a fulsome 82% of its EBIT, which is stronger than we'd usually expect. That puts it in a very strong position to pay down debt.

Summing up

We could understand if investors are concerned about Ramelius Resources's liabilities, but we can be reassured by the fact it has has net cash of AU$195.8m. The cherry on top was that in converted 82% of that EBIT to free cash flow, bringing in AU$193m. So is Ramelius Resources's debt a risk? It doesn't seem so to us. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 1 warning sign for Ramelius Resources that you should be aware of.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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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