Is American Resources (NASDAQ:AREC) A Risky Investment?

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 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. As with many other companies American Resources Corporation (NASDAQ:AREC) makes use of debt. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

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. 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, 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 American Resources

How Much Debt Does American Resources Carry?

As you can see below, American Resources had US$23.4m of debt at June 2021, down from US$35.9m a year prior. However, its balance sheet shows it holds US$28.1m in cash, so it actually has US$4.66m net cash.

How Healthy Is American Resources' Balance Sheet?

We can see from the most recent balance sheet that American Resources had liabilities of US$27.2m falling due within a year, and liabilities of US$21.9m due beyond that. Offsetting these obligations, it had cash of US$28.1m as well as receivables valued at US$376.6k due within 12 months. So its liabilities total US$20.7m more than the combination of its cash and short-term receivables.

Since publicly traded American Resources shares are worth a total of US$118.3m, it seems unlikely that this level of liabilities would be a major threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. Despite its noteworthy liabilities, American Resources boasts net cash, so it's fair to say it does not have a heavy debt load! When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if American Resources can strengthen its balance sheet over time. 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, American Resources made a loss at the EBIT level, and saw its revenue drop to US$712k, which is a fall of 92%. To be frank that doesn't bode well.

So How Risky Is American Resources?

We have no doubt that loss making companies are, in general, riskier than profitable ones. And the fact is that over the last twelve months American Resources lost money at the earnings before interest and tax (EBIT) line. And over the same period it saw negative free cash outflow of US$24m and booked a US$21m accounting loss. Given it only has net cash of US$4.66m, the company may need to raise more capital if it doesn't reach break-even soon. Summing up, we're a little skeptical of this one, as it seems fairly risky in the absence of free cashflow. 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. For example, we've discovered 5 warning signs for American Resources (4 are a bit concerning!) that you should be aware of before investing here.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.
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