Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a 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. As with many other companies Aranjin Resources Ltd. (CVE:ARJN) makes use of debt. But is this debt a concern to shareholders?
Why Does Debt Bring Risk?
Debt assists a business until the business has trouble paying it off, either with new capital or with free 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. 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.
What Is Aranjin Resources's Net Debt?
As you can see below, at the end of September 2021, Aranjin Resources had CA$2.15m of debt, up from CA$703.9k a year ago. Click the image for more detail. However, it also had CA$918.2k in cash, and so its net debt is CA$1.23m.
How Strong Is Aranjin Resources' Balance Sheet?
We can see from the most recent balance sheet that Aranjin Resources had liabilities of CA$2.36m falling due within a year, and liabilities of CA$738.0k due beyond that. Offsetting this, it had CA$918.2k in cash and CA$49.5k in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CA$2.13m.
Of course, Aranjin Resources has a market capitalization of CA$13.5m, so these liabilities are probably manageable. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Aranjin Resources will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.
Given its lack of meaningful operating revenue, investors are probably hoping that Aranjin Resources finds some valuable resources, before it runs out of money.
Over the last twelve months Aranjin Resources produced an earnings before interest and tax (EBIT) loss. To be specific the EBIT loss came in at CA$772k. 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. So we think its balance sheet is a little strained, though not beyond repair. Another cause for caution is that is bled CA$255k in negative free cash flow over the last twelve months. So to be blunt we think it is risky. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. Be aware that Aranjin Resources is showing 4 warning signs in our investment analysis , and 1 of those makes us a bit uncomfortable...
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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