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. Importantly, Karora Resources Inc. (TSE:KRR) does carry debt. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

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. If things get really bad, the lenders can take control of the business. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Karora Resources

How Much Debt Does Karora Resources Carry?

As you can see below, at the end of September 2022, Karora Resources had CA$40.2m of debt, up from CA$33.9m a year ago. Click the image for more detail. However, its balance sheet shows it holds CA$57.6m in cash, so it actually has CA$17.4m net cash.

How Strong Is Karora Resources' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Karora Resources had liabilities of CA$60.2m due within 12 months and liabilities of CA$130.8m due beyond that. Offsetting these obligations, it had cash of CA$57.6m as well as receivables valued at CA$5.04m due within 12 months. So it has liabilities totalling CA$128.4m more than its cash and near-term receivables, combined.

Given Karora Resources has a market capitalization of CA$824.1m, 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. Despite its noteworthy liabilities, Karora Resources boasts net cash, so it's fair to say it does not have a heavy debt load!

It is just as well that Karora Resources's load is not too heavy, because its EBIT was down 55% over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. 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're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. 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. During the last three years, Karora Resources burned a lot of cash. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Summing Up

While Karora Resources does have more liabilities than liquid assets, it also has net cash of CA$17.4m. So although we see some areas for improvement, we're not too worried about Karora Resources's balance sheet. 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. To that end, you should learn about the 4 warning signs we've spotted with Karora Resources (including 1 which shouldn't be ignored) .

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.