Is Sandfire Resources (ASX:SFR) A Risky Investment?

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We can see that Sandfire Resources Limited (ASX:SFR) does use debt in its business. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. If things get really bad, the lenders can take control of the business. 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Sandfire Resources

What Is Sandfire Resources's Net Debt?

As you can see below, at the end of December 2021, Sandfire Resources had US$145.0m of debt, up from none a year ago. Click the image for more detail. However, its balance sheet shows it holds US$1.20b in cash, so it actually has US$1.06b net cash.

How Healthy Is Sandfire Resources' Balance Sheet?

The latest balance sheet data shows that Sandfire Resources had liabilities of US$294.2m due within a year, and liabilities of US$64.6m falling due after that. Offsetting this, it had US$1.20b in cash and US$16.7m in receivables that were due within 12 months. So it actually has US$859.6m more liquid assets than total liabilities.

This surplus strongly suggests that Sandfire Resources has a rock-solid balance sheet (and the debt is of no concern whatsoever). On this view, lenders should feel as safe as the beloved of a black-belt karate master. Succinctly put, Sandfire Resources boasts net cash, so it's fair to say it does not have a heavy debt load!

In addition to that, we're happy to report that Sandfire Resources has boosted its EBIT by 56%, thus reducing the spectre of future debt repayments. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Sandfire Resources'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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Sandfire Resources 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. Happily for any shareholders, Sandfire Resources actually produced more free cash flow than EBIT over the last three years. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Summing up

While it is always sensible to investigate a company's debt, in this case Sandfire Resources has US$1.06b in net cash and a decent-looking balance sheet. The cherry on top was that in converted 104% of that EBIT to free cash flow, bringing in US$225m. The bottom line is that Sandfire Resources's use of debt is absolutely fine. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. We've identified 4 warning signs with Sandfire Resources (at least 2 which are potentially serious) , and understanding them should be part of your investment process.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.