We Think Rainbow Rare Earths (LON:RBW) Has A Fair Chunk Of Debt

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. Importantly, Rainbow Rare Earths Limited (LON:RBW) does carry debt. But the more important question is: how much risk is that debt creating?

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. If things get really bad, the lenders can take control of the business. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Rainbow Rare Earths

What Is Rainbow Rare Earths's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of June 2021 Rainbow Rare Earths had US$1.89m of debt, an increase on US$1.68m, over one year. However, it does have US$573.0k in cash offsetting this, leading to net debt of about US$1.32m.

A Look At Rainbow Rare Earths' Liabilities

The latest balance sheet data shows that Rainbow Rare Earths had liabilities of US$2.25m due within a year, and liabilities of US$792.0k falling due after that. Offsetting these obligations, it had cash of US$573.0k as well as receivables valued at US$370.0k due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$2.10m.

Of course, Rainbow Rare Earths has a market capitalization of US$96.1m, so these liabilities are probably manageable. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. Carrying virtually no net debt, Rainbow Rare Earths has a very light debt load indeed. When analysing debt levels, the balance sheet is the obvious place to start. But it is Rainbow Rare Earths's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Over 12 months, Rainbow Rare Earths reported revenue of US$639k, which is a gain of 51%, although it did not report any earnings before interest and tax. With any luck the company will be able to grow its way to profitability.

Caveat Emptor

Even though Rainbow Rare Earths managed to grow its top line quite deftly, the cold hard truth is that it is losing money on the EBIT line. Indeed, it lost US$2.7m at the EBIT level. 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$4.6m of cash over the last year. So to be blunt we think it is risky. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. These risks can be hard to spot. Every company has them, and we've spotted 6 warning signs for Rainbow Rare Earths (of which 3 can't be ignored!) you should know about.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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.

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