These 4 Measures Indicate That Newton Resources (HKG:1231) Is Using Debt Reasonably Well

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We note that Newton Resources Ltd (HKG:1231) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own 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.

View our latest analysis for Newton Resources

What Is Newton Resources's Debt?

The image below, which you can click on for greater detail, shows that Newton Resources had debt of US$4.43m at the end of June 2023, a reduction from US$4.69m over a year. But it also has US$10.3m in cash to offset that, meaning it has US$5.88m net cash.

How Healthy Is Newton Resources' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Newton Resources had liabilities of US$39.0m due within 12 months and liabilities of US$71.0k due beyond that. On the other hand, it had cash of US$10.3m and US$27.8m worth of receivables due within a year. So it has liabilities totalling US$933.0k more than its cash and near-term receivables, combined.

Having regard to Newton Resources' size, it seems that its liquid assets are well balanced with its total liabilities. So it's very unlikely that the US$306.5m company is short on cash, but still worth keeping an eye on the balance sheet. While it does have liabilities worth noting, Newton Resources also has more cash than debt, so we're pretty confident it can manage its debt safely.

Notably, Newton Resources made a loss at the EBIT level, last year, but improved that to positive EBIT of US$888k in the last twelve months. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Newton Resources will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. While Newton 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 year, Newton Resources saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.

Summing Up

While it is always sensible to look at a company's total liabilities, it is very reassuring that Newton Resources has US$5.88m in net cash. So we don't have any problem with Newton Resources's use of debt. 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. For instance, we've identified 1 warning sign for Newton Resources that you should be aware of.

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.

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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.