Is Erdene Resource Development (TSE:ERD) Using Too Much Debt?

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. As with many other companies Erdene Resource Development Corporation (TSE:ERD) makes use of debt. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. 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. 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

What Is Erdene Resource Development's Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2023 Erdene Resource Development had CA$34.0m of debt, an increase on none, over one year. However, because it has a cash reserve of CA$28.3m, its net debt is less, at about CA$5.67m.

How Strong Is Erdene Resource Development's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Erdene Resource Development had liabilities of CA$45.8m due within 12 months and no liabilities due beyond that. On the other hand, it had cash of CA$28.3m and CA$77.1k worth of receivables due within a year. So its liabilities total CA$17.4m more than the combination of its cash and short-term receivables.

Given Erdene Resource Development has a market capitalization of CA$131.1m, it's hard to believe these liabilities pose much threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. 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 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.

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.

Caveat Emptor

Importantly, Erdene Resource Development had an earnings before interest and tax (EBIT) loss over the last year. Indeed, it lost CA$5.9m at the EBIT level. Considering that alongside the liabilities mentioned above does not give us much confidence that company should be using so much debt. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. 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. 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. For example Erdene Resource Development has 3 warning signs (and 2 which are potentially serious) we think you should know about.

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.