Sandfire Resources (ASX:SFR) Has A Pretty Healthy Balance Sheet

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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 note that Sandfire Resources Limited (ASX:SFR) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for Sandfire Resources

What Is Sandfire Resources's Net Debt?

The chart below, which you can click on for greater detail, shows that Sandfire Resources had US$560.3m in debt in June 2024; about the same as the year before. On the flip side, it has US$183.3m in cash leading to net debt of about US$377.0m.

How Healthy Is Sandfire Resources' Balance Sheet?

The latest balance sheet data shows that Sandfire Resources had liabilities of US$227.6m due within a year, and liabilities of US$1.10b falling due after that. Offsetting these obligations, it had cash of US$183.3m as well as receivables valued at US$78.7m due within 12 months. So its liabilities total US$1.07b more than the combination of its cash and short-term receivables.

Sandfire Resources has a market capitalization of US$2.73b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Sandfire Resources has a very low debt to EBITDA ratio of 1.1 so it is strange to see weak interest coverage, with last year's EBIT being only 0.88 times the interest expense. So one way or the other, it's clear the debt levels are not trivial. We also note that Sandfire Resources improved its EBIT from a last year's loss to a positive US$49m. 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 want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So it's worth checking how much of the earnings before interest and tax (EBIT) is backed by free cash flow. Happily for any shareholders, Sandfire Resources actually produced more free cash flow than EBIT over the last year. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Our View

Sandfire Resources's interest cover was a real negative on this analysis, although the other factors we considered were considerably better. There's no doubt that its ability to to convert EBIT to free cash flow is pretty flash. Considering this range of data points, we think Sandfire Resources is in a good position to manage its debt levels. But a word of caution: we think debt levels are high enough to justify ongoing monitoring. Even though Sandfire Resources lost money on the bottom line, its positive EBIT suggests the business itself has potential. So you might want to check out how earnings have been trending over the last few years.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.