Here's Why Resolute Mining (ASX:RSG) Can Afford Some Debt

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 Resolute Mining Limited (ASX:RSG) makes use of debt. But should shareholders be worried about its use of debt?

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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Resolute Mining

How Much Debt Does Resolute Mining Carry?

The image below, which you can click on for greater detail, shows that Resolute Mining had debt of US$336.2m at the end of December 2020, a reduction from US$426.8m over a year. On the flip side, it has US$124.6m in cash leading to net debt of about US$211.6m.

How Healthy Is Resolute Mining's Balance Sheet?

According to the last reported balance sheet, Resolute Mining had liabilities of US$242.6m due within 12 months, and liabilities of US$367.3m due beyond 12 months. Offsetting this, it had US$124.6m in cash and US$96.8m in receivables that were due within 12 months. So its liabilities total US$388.5m more than the combination of its cash and short-term receivables.

This deficit is considerable relative to its market capitalization of US$515.4m, so it does suggest shareholders should keep an eye on Resolute Mining's use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution. 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 Resolute Mining'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.

In the last year Resolute Mining wasn't profitable at an EBIT level, but managed to grow its revenue by 31%, to US$603m. With any luck the company will be able to grow its way to profitability.

Caveat Emptor

Despite the top line growth, Resolute Mining still had an earnings before interest and tax (EBIT) loss over the last year. Indeed, it lost US$252k 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 US$41m of cash over the last year. So in short it's a really risky stock. 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. To that end, you should be aware of the 2 warning signs we've spotted with Resolute Mining .

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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