Is Stanmore Resources (ASX:SMR) using too much debt?
Howard Marks said it well when he said that, rather than worrying about stock price volatility, “the possibility of permanent loss is the risk I worry about…and that every practical investor that I know is worried”. So it may be obvious that you need to take debt into account when thinking about the risk of a given stock, because too much debt can sink a business. Like many other companies Stanmore Resources Limited (ASX:SMR) uses debt. But the more important question is: what risk does this debt create?
What risk does debt carry?
Debt and other liabilities become risky for a business when it cannot easily meet those obligations, either with free cash flow or by raising capital at an attractive price. If things go really bad, lenders can take over the business. However, a more common (but still painful) scenario is that it has to raise new equity at a low price, thereby permanently diluting shareholders. Of course, the advantage of debt is that it often represents cheap capital, especially when it replaces dilution in a business with the ability to reinvest at high rates of return. When we think about a company’s use of debt, we first look at cash and debt together.
See our latest analysis for Stanmore Resources
What is Stanmore Resources net debt?
As you can see below, at the end of June 2022, Stanmore Resources had $776.6 million in debt, up from $43.6 million a year ago. Click on the image for more details. However, he has $546.1 million in cash to offset this, resulting in a net debt of approximately $230.5 million.
How strong is Stanmore Resources’ balance sheet?
The latest balance sheet data shows that Stanmore Resources had liabilities of $729.5 million due within the year, and liabilities of $1.63 billion due thereafter. On the other hand, it had a cash position of 546.1 million dollars and 378.7 million dollars of receivables at less than one year. Thus, its liabilities total $1.44 billion more than the combination of its cash and short-term receivables.
When you consider that this shortfall exceeds the company’s market capitalization of US$1.41 billion, you might well be inclined to take a close look at the balance sheet. In theory, extremely large dilution would be required if the company were forced to repay its debts by raising capital at the current share price.
In order to assess a company’s debt relative to its earnings, we calculate its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and its earnings before interest and taxes (EBIT) divided by its expenses. interest (its interest coverage). Thus, we consider debt to earnings with and without amortization and depreciation expense.
Stanmore Resources has a low net debt to EBITDA ratio of just 0.48. And its EBIT covers its interest charges 22.2 times. So we’re pretty relaxed about his super-conservative use of debt. Although Stanmore Resources posted an EBIT loss last year, it was also good to see that it generated $430 million in EBIT over the last twelve months. 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 Stanmore 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 forecast.
Finally, a company can only repay its debts with cold hard cash, not with book profits. It is therefore important to check how much of its earnings before interest and taxes (EBIT) converts into actual free cash flow. Over the past year, Stanmore Resources has actually produced more free cash flow than EBIT. This kind of high cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.
Our point of view
Stanmore Resources’ interest coverage was a real plus in this analysis, as was its conversion of EBIT to free cash flow. On the other hand, its level of total liabilities makes us a little less comfortable about its indebtedness. When you consider all the elements mentioned above, it seems to us that Stanmore Resources manages its debt rather well. That said, the charge is heavy enough that we recommend that any shareholder keep a close eye on it. The balance sheet is clearly the area to focus on when analyzing debt. However, not all investment risks reside on the balance sheet, far from it. Be aware that Stanmore Resources displays 2 warning signs in our investment analysis and 1 of them should not be ignored…
If you are interested in investing in companies that can generate profits without the burden of debt, then check out this free list of growing companies that have net cash on the balance sheet.
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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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