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These 4 Measures Indicate That Lucara Diamond (TSE:LUC) Is Using Debt Extensively

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a 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 Lucara Diamond Corp. (TSE:LUC) makes use of debt. But is this debt a concern to shareholders?

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. If things get really bad, the lenders can take control of the business. 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. 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. When we think about a company's use of debt, we first look at cash and debt together.

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Check out our latest analysis for Lucara Diamond

What Is Lucara Diamond's Debt?

The image below, which you can click on for greater detail, shows that at June 2019 Lucara Diamond had debt of US$5.01m, up from none in one year. But it also has US$7.10m in cash to offset that, meaning it has US$2.10m net cash.

TSX:LUC Historical Debt, August 28th 2019
TSX:LUC Historical Debt, August 28th 2019

How Strong Is Lucara Diamond's Balance Sheet?

We can see from the most recent balance sheet that Lucara Diamond had liabilities of US$25.4m falling due within a year, and liabilities of US$91.7m due beyond that. Offsetting this, it had US$7.10m in cash and US$5.86m in receivables that were due within 12 months. So its liabilities total US$104.2m more than the combination of its cash and short-term receivables.

Lucara Diamond has a market capitalization of US$316.7m, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt. While it does have liabilities worth noting, Lucara Diamond also has more cash than debt, so we're pretty confident it can manage its debt safely.

Shareholders should be aware that Lucara Diamond's EBIT was down 77% last year. If that decline continues then paying off debt will be harder than selling foie gras at a vegan convention. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Lucara Diamond 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 Lucara Diamond 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. In the last three years, Lucara Diamond created free cash flow amounting to 6.0% of its EBIT, an uninspiring performance. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.

Summing up

While Lucara Diamond does have more liabilities than liquid assets, it also has net cash of US$2.1m. Despite its cash we think that Lucara Diamond seems to struggle to grow its EBIT, so we are wary of the stock. Given our hesitation about the stock, it would be good to know if Lucara Diamond insiders have sold any shares recently. You click here to find out if insiders have sold recently.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. 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. Simply Wall St has no position in the stocks mentioned. Thank you for reading.