African Rainbow Minerals (JSE:ARI) Could Easily Take On More Debt

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. As with many other companies African Rainbow Minerals Limited (JSE:ARI) makes use of debt. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for African Rainbow Minerals

How Much Debt Does African Rainbow Minerals Carry?

The image below, which you can click on for greater detail, shows that African Rainbow Minerals had debt of R940.0m at the end of June 2021, a reduction from R1.55b over a year. But on the other hand it also has R10.2b in cash, leading to a R9.25b net cash position.

How Healthy Is African Rainbow Minerals' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that African Rainbow Minerals had liabilities of R3.36b due within 12 months and liabilities of R5.96b due beyond that. Offsetting this, it had R10.2b in cash and R7.90b in receivables that were due within 12 months. So it can boast R8.78b more liquid assets than total liabilities.

This surplus suggests that African Rainbow Minerals is using debt in a way that is appears to be both safe and conservative. Because it has plenty of assets, it is unlikely to have trouble with its lenders. Succinctly put, African Rainbow Minerals boasts net cash, so it's fair to say it does not have a heavy debt load!

Better yet, African Rainbow Minerals grew its EBIT by 269% last year, which is an impressive improvement. That boost will make it even easier to pay down debt going forward. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if African Rainbow Minerals 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While African Rainbow Minerals 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 three years, African Rainbow Minerals actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Summing up

While it is always sensible to investigate a company's debt, in this case African Rainbow Minerals has R9.25b in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of R7.0b, being 113% of its EBIT. The bottom line is that we do not find African Rainbow Minerals's debt levels at all concerning. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should learn about the 3 warning signs we've spotted with African Rainbow Minerals (including 1 which can't be ignored) .

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.
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