Is Eastern Platinum (TSE:ELR) A Risky Investment?

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. As with many other companies Eastern Platinum Limited (TSE:ELR) makes use of debt. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own 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, 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.

See our latest analysis for Eastern Platinum

What Is Eastern Platinum's Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2023 Eastern Platinum had US$52.3m of debt, an increase on US$49.5m, over one year. However, because it has a cash reserve of US$17.3m, its net debt is less, at about US$35.0m.

How Healthy Is Eastern Platinum's Balance Sheet?

According to the last reported balance sheet, Eastern Platinum had liabilities of US$70.7m due within 12 months, and liabilities of US$7.03m due beyond 12 months. Offsetting this, it had US$17.3m in cash and US$27.6m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$32.8m.

When you consider that this deficiency exceeds the company's US$24.1m market capitalization, you might well be inclined to review the balance sheet intently. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

While we wouldn't worry about Eastern Platinum's net debt to EBITDA ratio of 2.5, we think its super-low interest cover of 2.4 times is a sign of high leverage. So shareholders should probably be aware that interest expenses appear to have really impacted the business lately. Notably, Eastern Platinum's EBIT launched higher than Elon Musk, gaining a whopping 3,844% on last year. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Eastern Platinum 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.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. In the last two years, Eastern Platinum's free cash flow amounted to 43% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Our View

On the face of it, Eastern Platinum's interest cover left us tentative about the stock, and its level of total liabilities was no more enticing than the one empty restaurant on the busiest night of the year. But at least it's pretty decent at growing its EBIT; that's encouraging. Looking at the balance sheet and taking into account all these factors, we do believe that debt is making Eastern Platinum stock a bit risky. Some people like that sort of risk, but we're mindful of the potential pitfalls, so we'd probably prefer it carry less debt. When analysing debt levels, the balance sheet is the obvious place to start. 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 4 warning signs for Eastern Platinum (of which 1 makes us a bit uncomfortable!) you should know about.

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.