We Think Exxaro Resources (JSE:EXX) Can Stay On Top Of Its Debt

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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We can see that Exxaro Resources Limited (JSE:EXX) does use debt in its business. But is this debt a concern to shareholders?

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 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, 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.

Check out our latest analysis for Exxaro Resources

What Is Exxaro Resources's Debt?

As you can see below, Exxaro Resources had R8.92b of debt, at December 2023, which is about the same as the year before. You can click the chart for greater detail. But it also has R19.9b in cash to offset that, meaning it has R10.9b net cash.

How Healthy Is Exxaro Resources' Balance Sheet?

The latest balance sheet data shows that Exxaro Resources had liabilities of R6.22b due within a year, and liabilities of R20.2b falling due after that. On the other hand, it had cash of R19.9b and R3.88b worth of receivables due within a year. So it has liabilities totalling R2.71b more than its cash and near-term receivables, combined.

Of course, Exxaro Resources has a market capitalization of R39.8b, 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.

The modesty of its debt load may become crucial for Exxaro Resources if management cannot prevent a repeat of the 32% cut to EBIT over the last year. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Exxaro 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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Exxaro Resources may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Over the last three years, Exxaro Resources recorded free cash flow worth a fulsome 81% of its EBIT, which is stronger than we'd usually expect. That puts it in a very strong position to pay down debt.

Summing Up

We could understand if investors are concerned about Exxaro Resources's liabilities, but we can be reassured by the fact it has has net cash of R10.9b. The cherry on top was that in converted 81% of that EBIT to free cash flow, bringing in R8.4b. So we are not troubled with Exxaro Resources's debt use. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 2 warning signs for Exxaro Resources you should be aware of, and 1 of them is significant.

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.