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.' 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 Sandfire Resources Limited (ASX:SFR) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Sandfire Resources

What Is Sandfire Resources's Net Debt?

The image below, which you can click on for greater detail, shows that at December 2021 Sandfire Resources had debt of US$145.0m, up from none in one year. However, its balance sheet shows it holds US$1.20b in cash, so it actually has US$1.06b net cash.

A Look At Sandfire Resources' Liabilities

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. On the other hand, it had cash of US$1.20b and US$16.7m worth of receivables due within a year. 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!

On top of that, Sandfire Resources grew its EBIT by 56% over the last twelve months, and that growth will make it easier to handle its debt. 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 Sandfire 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 company can only pay off debt with cold hard cash, not accounting profits. 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. Over the last three years, Sandfire Resources actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

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. And it impressed us with free cash flow of US$225m, being 104% of its EBIT. At the end of the day we're not concerned about Sandfire Resources's 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. Be aware that Sandfire Resources is showing 4 warning signs in our investment analysis , and 2 of those make us uncomfortable...

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.