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 Northern Star Resources Limited (ASX:NST) makes use of debt. But the real question is whether this debt is making the company risky.
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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
How Much Debt Does Northern Star Resources Carry?
The image below, which you can click on for greater detail, shows that at December 2019 Northern Star Resources had debt of AU$495.2m, up from none in one year. But on the other hand it also has AU$1.37b in cash, leading to a AU$870.1m net cash position.
How Healthy Is Northern Star Resources's Balance Sheet?
The latest balance sheet data shows that Northern Star Resources had liabilities of AU$303.2m due within a year, and liabilities of AU$832.7m falling due after that. On the other hand, it had cash of AU$1.37b and AU$71.6m worth of receivables due within a year. So it can boast AU$301.1m more liquid assets than total liabilities.
This surplus suggests that Northern Star Resources has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Northern Star Resources has more cash than debt is arguably a good indication that it can manage its debt safely.
But the other side of the story is that Northern Star Resources saw its EBIT decline by 8.4% over the last year. If earnings continue to decline at that rate the company may have increasing difficulty managing its debt load. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Northern Star Resources 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.
Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Northern Star Resources 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, Northern Star Resources produced sturdy free cash flow equating to 63% 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.
While we empathize with investors who find debt concerning, you should keep in mind that Northern Star Resources has net cash of AU$870.1m, as well as more liquid assets than liabilities. So we don't have any problem with Northern Star Resources's use of debt. 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. Take risks, for example - Northern Star Resources has 1 warning sign we think you should be aware of.
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.
This article by Simply Wall St is general in nature. 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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