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Is Pilbara Minerals (ASX:PLS) Using Too Much Debt?

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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.' 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 Pilbara Minerals Limited (ASX:PLS) makes use of debt. But is this debt a concern to shareholders?

When Is Debt A Problem?

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. 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. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Pilbara Minerals

What Is Pilbara Minerals's Debt?

As you can see below, at the end of December 2021, Pilbara Minerals had AU$171.3m of debt, up from AU$137.0m a year ago. Click the image for more detail. But on the other hand it also has AU$191.2m in cash, leading to a AU$19.9m net cash position.

debt-equity-history-analysis
debt-equity-history-analysis

How Healthy Is Pilbara Minerals' Balance Sheet?

According to the last reported balance sheet, Pilbara Minerals had liabilities of AU$153.6m due within 12 months, and liabilities of AU$200.7m due beyond 12 months. On the other hand, it had cash of AU$191.2m and AU$70.4m worth of receivables due within a year. So its liabilities total AU$92.7m more than the combination of its cash and short-term receivables.

Having regard to Pilbara Minerals' size, it seems that its liquid assets are well balanced with its total liabilities. So while it's hard to imagine that the AU$8.66b company is struggling for cash, we still think it's worth monitoring its balance sheet. While it does have liabilities worth noting, Pilbara Minerals also has more cash than debt, so we're pretty confident it can manage its debt safely.

Although Pilbara Minerals made a loss at the EBIT level, last year, it was also good to see that it generated AU$139m in EBIT over the last twelve months. 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 Pilbara Minerals's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Pilbara Minerals may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Over the most recent year, Pilbara Minerals recorded free cash flow worth 52% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Summing up

While it is always sensible to look at a company's total liabilities, it is very reassuring that Pilbara Minerals has AU$19.9m in net cash. So we are not troubled with Pilbara Minerals's debt use. 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. We've identified 2 warning signs with Pilbara Minerals , and understanding them should be part of your investment process.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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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