Is Lucara Diamond (TSE:LUC) A Risky Investment?

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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 note that Lucara Diamond Corp. (TSE:LUC) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for Lucara Diamond

How Much Debt Does Lucara Diamond Carry?

The image below, which you can click on for greater detail, shows that at December 2020 Lucara Diamond had debt of US$30.5m, up from none in one year. However, because it has a cash reserve of US$4.92m, its net debt is less, at about US$25.6m.

How Strong Is Lucara Diamond's Balance Sheet?

According to the last reported balance sheet, Lucara Diamond had liabilities of US$47.6m due within 12 months, and liabilities of US$78.1m due beyond 12 months. Offsetting this, it had US$4.92m in cash and US$18.5m in receivables that were due within 12 months. So its liabilities total US$102.3m more than the combination of its cash and short-term receivables.

Lucara Diamond has a market capitalization of US$268.3m, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Lucara Diamond'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.

Over 12 months, Lucara Diamond made a loss at the EBIT level, and saw its revenue drop to US$125m, which is a fall of 35%. That makes us nervous, to say the least.

Caveat Emptor

While Lucara Diamond's falling revenue is about as heartwarming as a wet blanket, arguably its earnings before interest and tax (EBIT) loss is even less appealing. Its EBIT loss was a whopping US$29m. When we look at that and recall the liabilities on its balance sheet, relative to cash, it seems unwise to us for the company to have any 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 US$35m of cash over the last year. So suffice it to say we consider the stock very risky. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 1 warning sign for Lucara Diamond that you should be aware of.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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