David Iben said it well when he said: “Volatility is not a risk that interests us. What matters to us is to avoid the permanent loss of capital. So it seems smart money knows that debt – which is usually involved in bankruptcies – is a very important factor when you’re assessing a company’s risk. Like many other companies Limited West African resources (ASX: WAF) resorts to debt. But the real question is whether this debt makes the business risky.
Why is debt risky?
Debt is a tool to help businesses grow, but if a business is unable to repay its lenders, it exists at their mercy. In the worst case, a company can go bankrupt if it cannot pay its creditors. However, a more usual (but still expensive) situation is when a company has to dilute shareholders at a cheap share price just to keep debt under control. That said, the most common situation is when a company manages its debt reasonably well – and to its own benefit. The first thing to do when considering how much debt a business has is to look at its cash and debt together.
What is West Africa’s resource debt?
You can click on the chart below for historical figures, but it shows West African Resources had A$79.3m in debt in June 2022, up from A$148.7m a year earlier. However, he has A$221.8 million in cash to offset this, which translates to a net cash of A$142.5 million.
How strong is West African Resources’ balance sheet?
We can see from the most recent balance sheet that West African Resources had liabilities of A$153.6m due within a year, and liabilities of A$56.7m due beyond . On the other hand, it had cash of A$221.8 million and A$31.9 million of receivables due within a year. So he actually has 43.4 million Australian dollars After liquid assets than total liabilities.
This surplus suggests that West African Resources has a conservative balance sheet, and could probably eliminate its debt without too much difficulty. Put simply, the fact that West African Resources has more cash than debt is arguably a good indication that it can safely manage its debt.
In addition, West African Resources has increased its EBIT by 57% over the last twelve months, and this growth will make it easier to manage its debt. There is no doubt that we learn the most about debt from the balance sheet. But it is future earnings, more than anything, that will determine West African Resources’ ability to maintain a healthy balance sheet in the future. So if you are focused on the future, you can check out this free report showing analyst earnings forecasts.
Finally, while the taxman may love accounting profits, lenders only accept cash. West African Resources may have net cash on the balance sheet, but it is always interesting to see how well the company converts its earnings before interest and tax (EBIT) into free cash flow, as this will influence both its needs and its ability to manage debt. Over the past three years, West African Resources has recorded free cash flow of 28% of its EBIT, which is lower than expected. It’s not great when it comes to paying off debt.
While it’s always a good idea to investigate a company’s debt, in this case West African Resources has A$142.5 million in net cash and a decent balance sheet. And we liked the look of EBIT growth of 57% YoY last year. Is the debt of West African Resources then a risk? This does not seem to us to be the case. When analyzing debt levels, the balance sheet is the obvious starting point. But at the end of the day, every business can contain risks that exist outside of the balance sheet. To this end, you should be aware of the 1 warning sign we spotted with West African Resources .
If after all this you are more interested in a fast growing company with a strong balance sheet, then check out our list of net cash growth stocks without delay.
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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.
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