Exxaro Resources (JSE:EXX) Seems To Use Debt Rather Sparingly

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. We can see that Exxaro Resources Limited (JSE:EXX) does use debt in its business. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

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. If things get really bad, the lenders can take control of the business. 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, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Exxaro Resources

What Is Exxaro Resources's Net Debt?

The image below, which you can click on for greater detail, shows that Exxaro Resources had debt of R9.21b at the end of December 2022, a reduction from R10.7b over a year. But on the other hand it also has R14.8b in cash, leading to a R5.61b net cash position.

How Healthy Is Exxaro Resources' Balance Sheet?

The latest balance sheet data shows that Exxaro Resources had liabilities of R5.19b due within a year, and liabilities of R20.6b falling due after that. Offsetting these obligations, it had cash of R14.8b as well as receivables valued at R4.73b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by R6.23b.

Of course, Exxaro Resources has a market capitalization of R39.4b, 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. While it does have liabilities worth noting, Exxaro Resources also has more cash than debt, so we're pretty confident it can manage its debt safely.

Even more impressive was the fact that Exxaro Resources grew its EBIT by 113% over twelve months. If maintained that growth will make the debt even more manageable in the years ahead. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Exxaro Resources's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Exxaro 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. During the last three years, Exxaro Resources produced sturdy free cash flow equating to 76% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing Up

Although Exxaro Resources's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of R5.61b. And we liked the look of last year's 113% year-on-year EBIT growth. So is Exxaro Resources's debt a risk? It doesn't seem so to us. 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. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for Exxaro Resources (of which 1 is concerning!) you should know about.

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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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.