African Rainbow Minerals (JSE:ARI) Seems To Use Debt Rather Sparingly

By
Simply Wall St
Published
April 16, 2022
JSE:ARI
Source: Shutterstock

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We can see that African Rainbow Minerals Limited (JSE:ARI) does use debt in its business. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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. When we think about a company's use of debt, we first look at 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 R819.0m at the end of December 2021, a reduction from R1.71b over a year. But on the other hand it also has R12.9b in cash, leading to a R12.1b net cash position.

debt-equity-history-analysis
JSE:ARI Debt to Equity History April 16th 2022

How Healthy Is African Rainbow Minerals' Balance Sheet?

We can see from the most recent balance sheet that African Rainbow Minerals had liabilities of R3.39b falling due within a year, and liabilities of R5.83b due beyond that. Offsetting this, it had R12.9b in cash and R6.29b in receivables that were due within 12 months. So it can boast R9.98b more liquid assets than total liabilities.

This excess liquidity suggests that African Rainbow Minerals is taking a careful approach to debt. Due to its strong net asset position, it is not likely to face issues 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!

In addition to that, we're happy to report that African Rainbow Minerals has boosted its EBIT by 45%, thus reducing the spectre of future debt repayments. 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. Happily for any shareholders, African Rainbow Minerals actually produced more free cash flow than EBIT over the last three years. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Summing up

While it is always sensible to investigate a company's debt, in this case African Rainbow Minerals has R12.1b in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of R12b, being 126% of its EBIT. The bottom line is that we do not find African Rainbow Minerals's debt levels at all concerning. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. To that end, you should learn about the 2 warning signs we've spotted with African Rainbow Minerals (including 1 which is significant) .

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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