Would American Resources (NASDAQ:AREC) Be Better Off With Less Debt?

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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. Importantly, American Resources Corporation (NASDAQ:AREC) does carry debt. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. 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, at the end of September 2023, American Resources had US$44.0m of debt, up from US$12.0m a year ago. Click the image for more detail. However, it does have US$3.12m in cash offsetting this, leading to net debt of about US$40.9m.

How Healthy Is American Resources' Balance Sheet?

According to the last reported balance sheet, American Resources had liabilities of US$16.2m due within 12 months, and liabilities of US$72.0m due beyond 12 months. On the other hand, it had cash of US$3.12m and US$4.39m worth of receivables due within a year. So it has liabilities totalling US$80.7m more than its cash and near-term receivables, combined.

This deficit is considerable relative to its market capitalization of US$100.2m, so it does suggest shareholders should keep an eye on American Resources' use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution. 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're focused on the future you can check out this free report showing analyst profit forecasts.

Over 12 months, American Resources made a loss at the EBIT level, and saw its revenue drop to US$21m, which is a fall of 46%. That makes us nervous, to say the least.

Caveat Emptor

Not only did American Resources's revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). Its EBIT loss was a whopping US$20m. 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. Surprisingly, we note that it actually reported positive free cash flow of US$5.4m and a profit of US$8.4m. So if we focus on those metrics there seems to be a chance the company will manage its debt without much trouble. 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 American Resources has 5 warning signs (and 1 which is significant) we think you should know about.

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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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.