Karora Resources (TSE:KRR) Takes On Some Risk With Its Use Of Debt

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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 Karora Resources Inc. (TSE:KRR) makes use of debt. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. If things get really bad, the lenders can take control of the business. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Karora Resources

How Much Debt Does Karora Resources Carry?

As you can see below, Karora Resources had CA$31.3m of debt at June 2022, down from CA$33.6m a year prior. But on the other hand it also has CA$116.1m in cash, leading to a CA$84.8m net cash position.

How Strong Is Karora Resources' Balance Sheet?

According to the last reported balance sheet, Karora Resources had liabilities of CA$78.7m due within 12 months, and liabilities of CA$81.5m due beyond 12 months. On the other hand, it had cash of CA$116.1m and CA$3.80m worth of receivables due within a year. So it has liabilities totalling CA$40.4m more than its cash and near-term receivables, combined.

Of course, Karora Resources has a market capitalization of CA$536.9m, so these liabilities are probably manageable. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. Despite its noteworthy liabilities, Karora Resources boasts net cash, so it's fair to say it does not have a heavy debt load!

In fact Karora Resources's saving grace is its low debt levels, because its EBIT has tanked 33% in the last twelve months. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Karora Resources's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Karora Resources has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Over the last three years, Karora Resources reported free cash flow worth 7.0% of its EBIT, which is really quite low. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.

Summing Up

While it is always sensible to look at a company's total liabilities, it is very reassuring that Karora Resources has CA$84.8m in net cash. So although we see some areas for improvement, we're not too worried about Karora Resources's balance sheet. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should learn about the 3 warning signs we've spotted with Karora Resources (including 1 which shouldn't be ignored) .

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.