Is Terramin Australia (ASX:TZN) 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 might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We can see that Terramin Australia Limited (ASX:TZN) does use debt in its business. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

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 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 think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Terramin Australia

What Is Terramin Australia's Debt?

The image below, which you can click on for greater detail, shows that at June 2023 Terramin Australia had debt of AU$29.3m, up from AU$26.8m in one year. And it doesn't have much cash, so its net debt is about the same.

A Look At Terramin Australia's Liabilities

We can see from the most recent balance sheet that Terramin Australia had liabilities of AU$44.5m falling due within a year, and liabilities of AU$5.21m due beyond that. Offsetting this, it had AU$54.0k in cash and AU$167.0k in receivables that were due within 12 months. So it has liabilities totalling AU$49.5m more than its cash and near-term receivables, combined.

This is a mountain of leverage relative to its market capitalization of AU$52.9m. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Terramin Australia will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Given its lack of meaningful operating revenue, investors are probably hoping that Terramin Australia finds some valuable resources, before it runs out of money.

Caveat Emptor

Importantly, Terramin Australia had an earnings before interest and tax (EBIT) loss over the last year. Indeed, it lost a very considerable AU$18m at the EBIT level. When we look at that and recall the liabilities on its balance sheet, relative to cash, it seems unwise to us for the company to have any debt. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. However, it doesn't help that it burned through AU$2.7m of cash over the last year. So suffice it to say we consider the stock very risky. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should learn about the 4 warning signs we've spotted with Terramin Australia (including 3 which are a bit concerning) .

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. 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.