Is Erdene Resource Development (TSE:ERD) 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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. Importantly, Erdene Resource Development Corporation (TSE:ERD) does carry 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. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Erdene Resource Development

How Much Debt Does Erdene Resource Development Carry?

As you can see below, at the end of September 2023, Erdene Resource Development had CA$34.0m of debt, up from none a year ago. Click the image for more detail. However, because it has a cash reserve of CA$28.3m, its net debt is less, at about CA$5.67m.

How Healthy Is Erdene Resource Development's Balance Sheet?

According to the balance sheet data, Erdene Resource Development had liabilities of CA$45.8m due within 12 months, but no longer term liabilities. Offsetting these obligations, it had cash of CA$28.3m as well as receivables valued at CA$77.1k due within 12 months. So it has liabilities totalling CA$17.4m more than its cash and near-term receivables, combined.

Given Erdene Resource Development has a market capitalization of CA$106.8m, it's hard to believe these liabilities pose much threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. 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 if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Since Erdene Resource Development has no significant operating revenue, shareholders probably hope it will develop a valuable new mine before too long.

Caveat Emptor

Importantly, Erdene Resource Development had an earnings before interest and tax (EBIT) loss over the last year. To be specific the EBIT loss came in at CA$5.9m. Considering that alongside the liabilities mentioned above does not give us much confidence that company should be using so much debt. So we think its balance sheet is a little strained, though not beyond repair. However, it doesn't help that it burned through CA$16m of cash over the last year. So in short it's a really risky stock. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. Be aware that Erdene Resource Development is showing 4 warning signs in our investment analysis , and 2 of those don't sit too well with us...

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.