Kumba Iron Ore (JSE:KIO) Could Easily Take On More Debt

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' 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. As with many other companies Kumba Iron Ore Limited (JSE:KIO) makes use of debt. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

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. 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, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Kumba Iron Ore

What Is Kumba Iron Ore's Net Debt?

The image below, which you can click on for greater detail, shows that Kumba Iron Ore had debt of R4.14b at the end of December 2023, a reduction from R6.79b over a year. But on the other hand it also has R17.7b in cash, leading to a R13.6b net cash position.

How Strong Is Kumba Iron Ore's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Kumba Iron Ore had liabilities of R14.8b due within 12 months and liabilities of R15.7b due beyond that. Offsetting this, it had R17.7b in cash and R9.67b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by R3.11b.

Given Kumba Iron Ore has a market capitalization of R148.4b, it's hard to believe these liabilities pose much threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. Despite its noteworthy liabilities, Kumba Iron Ore boasts net cash, so it's fair to say it does not have a heavy debt load!

Another good sign is that Kumba Iron Ore has been able to increase its EBIT by 25% in twelve months, making it easier to pay down debt. 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 Kumba Iron Ore'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, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While Kumba Iron Ore 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, Kumba Iron Ore produced sturdy free cash flow equating to 64% 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

While it is always sensible to look at a company's total liabilities, it is very reassuring that Kumba Iron Ore has R13.6b in net cash. And it impressed us with its EBIT growth of 25% over the last year. So is Kumba Iron Ore's debt a risk? It doesn't seem so to us. 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. Case in point: We've spotted 2 warning signs for Kumba Iron Ore you should be aware of, and 1 of them is concerning.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.