Kumba Iron Ore (JSE:KIO) Seems To Use Debt Rather Sparingly

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says '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 Kumba Iron Ore Limited (JSE:KIO) does use debt in its business. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

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. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Kumba Iron Ore

What Is Kumba Iron Ore's Net Debt?

As you can see below, at the end of June 2024, Kumba Iron Ore had R1.00b of debt, up from R725.0m a year ago. Click the image for more detail. However, it does have R15.8b in cash offsetting this, leading to net cash of R14.8b.

A Look At Kumba Iron Ore's Liabilities

The latest balance sheet data shows that Kumba Iron Ore had liabilities of R9.80b due within a year, and liabilities of R16.3b falling due after that. Offsetting these obligations, it had cash of R15.8b as well as receivables valued at R5.88b due within 12 months. So its liabilities total R4.36b more than the combination of its cash and short-term receivables.

Of course, Kumba Iron Ore has a market capitalization of R103.4b, so these liabilities are probably manageable. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. Despite its noteworthy liabilities, Kumba Iron Ore boasts net cash, so it's fair to say it does not have a heavy debt load!

Also positive, Kumba Iron Ore grew its EBIT by 27% in the last year, and that should make it easier to pay down debt, going forward. When analysing debt levels, the balance sheet is the obvious place to start. 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 company can only pay off debt with cold hard cash, not accounting profits. 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 59% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Summing Up

We could understand if investors are concerned about Kumba Iron Ore's liabilities, but we can be reassured by the fact it has has net cash of R14.8b. And we liked the look of last year's 27% year-on-year EBIT growth. So we don't think Kumba Iron Ore's use of debt is risky. 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. For instance, we've identified 2 warning signs for Kumba Iron Ore (1 is a bit unpleasant) you should be aware of.

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.