Is Eastern Platinum (TSE:ELR) Using Debt Sensibly?

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' 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 the more important question is: how much risk is that debt creating?

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 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. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Eastern Platinum

What Is Eastern Platinum's Net Debt?

The chart below, which you can click on for greater detail, shows that Eastern Platinum had US$49.1m in debt in September 2021; about the same as the year before. However, it does have US$6.49m in cash offsetting this, leading to net debt of about US$42.6m.

A Look At Eastern Platinum's Liabilities

According to the last reported balance sheet, Eastern Platinum had liabilities of US$17.2m due within 12 months, and liabilities of US$67.2m due beyond 12 months. Offsetting this, it had US$6.49m in cash and US$22.6m in receivables that were due within 12 months. So its liabilities total US$55.3m more than the combination of its cash and short-term receivables.

The deficiency here weighs heavily on the US$31.3m company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we'd watch its balance sheet closely, without a doubt. After all, Eastern Platinum would likely require a major re-capitalisation if it had to pay its creditors today. When analysing debt levels, the balance sheet is the obvious place to start. But it is Eastern Platinum's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

In the last year Eastern Platinum wasn't profitable at an EBIT level, but managed to grow its revenue by 31%, to US$68m. Shareholders probably have their fingers crossed that it can grow its way to profits.

Caveat Emptor

Even though Eastern Platinum managed to grow its top line quite deftly, the cold hard truth is that it is losing money on the EBIT line. To be specific the EBIT loss came in at US$2.4m. When we look at that alongside the significant liabilities, we're not particularly confident about the company. It would need to improve its operations quickly for us to be interested in it. Not least because it had negative free cash flow of US$10m over the last twelve months. So suffice it to say we consider the stock to be risky. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. We've identified 4 warning signs with Eastern Platinum (at least 1 which is concerning) , and understanding them should be part of your investment process.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.