Stanmore Resources (ASX:SMR) Has A Rock Solid Balance Sheet

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.' 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 Stanmore Resources Limited (ASX:SMR) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

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. If things get really bad, the lenders can take control of the business. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Stanmore Resources

What Is Stanmore Resources's Net Debt?

As you can see below, Stanmore Resources had US$343.9m of debt at June 2023, down from US$776.6m a year prior. However, its balance sheet shows it holds US$420.9m in cash, so it actually has US$77.0m net cash.

How Strong Is Stanmore Resources' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Stanmore Resources had liabilities of US$689.1m due within 12 months and liabilities of US$976.9m due beyond that. Offsetting this, it had US$420.9m in cash and US$253.7m in receivables that were due within 12 months. So it has liabilities totalling US$991.4m more than its cash and near-term receivables, combined.

While this might seem like a lot, it is not so bad since Stanmore Resources has a market capitalization of US$2.21b, and so it could probably strengthen its balance sheet by raising capital if it needed to. However, it is still worthwhile taking a close look at its ability to pay off debt. Despite its noteworthy liabilities, Stanmore Resources boasts net cash, so it's fair to say it does not have a heavy debt load!

Better yet, Stanmore Resources grew its EBIT by 148% last year, which is an impressive improvement. If maintained that growth will make the debt even more manageable in the years ahead. 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 Stanmore 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Stanmore 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. During the last two years, Stanmore Resources generated free cash flow amounting to a very robust 98% of its EBIT, more than we'd expect. That positions it well to pay down debt if desirable to do so.

Summing Up

Although Stanmore Resources's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of US$77.0m. And it impressed us with free cash flow of US$886m, being 98% of its EBIT. So we don't think Stanmore Resources's use of debt is risky. 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. These risks can be hard to spot. Every company has them, and we've spotted 1 warning sign for Stanmore Resources you should know about.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.