Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We can see that Burgundy Diamond Mines Limited (ASX:BDM) does use debt in its business. But should shareholders be worried about its use of debt?
When Is Debt A Problem?
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. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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. When we examine debt levels, we first consider both cash and debt levels, together.
What Is Burgundy Diamond Mines's Debt?
The image below, which you can click on for greater detail, shows that at December 2021 Burgundy Diamond Mines had debt of AU$27.7m, up from none in one year. But it also has AU$30.2m in cash to offset that, meaning it has AU$2.44m net cash.
How Strong Is Burgundy Diamond Mines' Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Burgundy Diamond Mines had liabilities of AU$593.4k due within 12 months and liabilities of AU$28.4m due beyond that. On the other hand, it had cash of AU$30.2m and AU$1.62m worth of receivables due within a year. So it can boast AU$2.78m more liquid assets than total liabilities.
This surplus suggests that Burgundy Diamond Mines has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Burgundy Diamond Mines has more cash than debt is arguably a good indication that it can manage its debt safely. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Burgundy Diamond Mines will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.
Given its lack of meaningful operating revenue, investors are probably hoping that Burgundy Diamond Mines finds some valuable resources, before it runs out of money.
So How Risky Is Burgundy Diamond Mines?
We have no doubt that loss making companies are, in general, riskier than profitable ones. And we do note that Burgundy Diamond Mines had an earnings before interest and tax (EBIT) loss, over the last year. Indeed, in that time it burnt through AU$29m of cash and made a loss of AU$22m. But the saving grace is the AU$2.44m on the balance sheet. That means it could keep spending at its current rate for more than two years. Overall, its balance sheet doesn't seem overly risky, at the moment, but we're always cautious until we see the positive free cash flow. 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. We've identified 5 warning signs with Burgundy Diamond Mines (at least 3 which can't be ignored) , and understanding them should be part of your investment process.
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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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.