We Think Zimplats Holdings (ASX:ZIM) Is Taking Some Risk With Its Debt

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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. Importantly, Zimplats Holdings Limited (ASX:ZIM) does carry debt. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

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. 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. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest 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 Zimplats Holdings

What Is Zimplats Holdings's Net Debt?

As you can see below, at the end of June 2024, Zimplats Holdings had US$62.8m of debt, up from none a year ago. Click the image for more detail. However, it does have US$78.1m in cash offsetting this, leading to net cash of US$15.3m.

How Healthy Is Zimplats Holdings' Balance Sheet?

According to the last reported balance sheet, Zimplats Holdings had liabilities of US$244.6m due within 12 months, and liabilities of US$465.2m due beyond 12 months. Offsetting these obligations, it had cash of US$78.1m as well as receivables valued at US$288.0m due within 12 months. So it has liabilities totalling US$343.8m more than its cash and near-term receivables, combined.

While this might seem like a lot, it is not so bad since Zimplats Holdings has a market capitalization of US$1.02b, 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, Zimplats Holdings boasts net cash, so it's fair to say it does not have a heavy debt load!

In fact Zimplats Holdings's saving grace is its low debt levels, because its EBIT has tanked 76% in the last twelve months. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Zimplats Holdings's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Zimplats Holdings 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. In the last three years, Zimplats Holdings created free cash flow amounting to 9.5% of its EBIT, an uninspiring performance. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.

Summing Up

Although Zimplats Holdings'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$15.3m. So although we see some areas for improvement, we're not too worried about Zimplats Holdings's balance sheet. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 3 warning signs for Zimplats Holdings you should be aware of, and 2 of them are potentially serious.

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.