Is Erdene Resource Development (TSE:ERD) A Risky Investment?

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a 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. We can see that Erdene Resource Development Corporation (TSE:ERD) does use debt in its business. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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 Erdene Resource Development

What Is Erdene Resource Development's Debt?

You can click the graphic below for the historical numbers, but it shows that as of March 2023 Erdene Resource Development had CA$6.93m of debt, an increase on none, over one year. However, it does have CA$11.7m in cash offsetting this, leading to net cash of CA$4.78m.

How Strong Is Erdene Resource Development's Balance Sheet?

According to the last reported balance sheet, Erdene Resource Development had liabilities of CA$7.32m due within 12 months, and liabilities of CA$14.4k due beyond 12 months. On the other hand, it had cash of CA$11.7m and CA$72.9k worth of receivables due within a year. So it can boast CA$4.45m more liquid assets than total liabilities.

This short term liquidity is a sign that Erdene Resource Development could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, Erdene Resource Development boasts net cash, so it's fair to say it does not have a heavy debt load! There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Erdene Resource Development 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 Erdene Resource Development finds some valuable resources, before it runs out of money.

So How Risky Is Erdene Resource Development?

We have no doubt that loss making companies are, in general, riskier than profitable ones. And we do note that Erdene Resource Development had an earnings before interest and tax (EBIT) loss, over the last year. Indeed, in that time it burnt through CA$13m of cash and made a loss of CA$5.9m. Given it only has net cash of CA$4.78m, the company may need to raise more capital if it doesn't reach break-even soon. Even though its balance sheet seems sufficiently liquid, debt always makes us a little nervous if a company doesn't produce free cash flow regularly. 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. We've identified 5 warning signs with Erdene Resource Development (at least 3 which make us uncomfortable) , and understanding them should be part of your investment process.

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.