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Is Allkem (ASX:AKE) A Risky Investment?

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. Importantly, Allkem Limited (ASX:AKE) does carry debt. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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.

See our latest analysis for Allkem

What Is Allkem's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of December 2021 Allkem had US$333.5m of debt, an increase on US$251.0m, over one year. But on the other hand it also has US$449.8m in cash, leading to a US$116.3m net cash position.

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

How Strong Is Allkem's Balance Sheet?

According to the last reported balance sheet, Allkem had liabilities of US$132.2m due within 12 months, and liabilities of US$1.15b due beyond 12 months. On the other hand, it had cash of US$449.8m and US$31.8m worth of receivables due within a year. So its liabilities total US$799.2m more than the combination of its cash and short-term receivables.

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Of course, Allkem has a market capitalization of US$5.54b, so these liabilities are probably manageable. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. While it does have liabilities worth noting, Allkem also has more cash than debt, so we're pretty confident it can manage its debt safely.

Notably, Allkem made a loss at the EBIT level, last year, but improved that to positive EBIT of US$69m in the last twelve months. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Allkem'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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Allkem 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. During the last year, Allkem burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Summing up

Although Allkem's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of US$116.3m. So while Allkem does not have a great balance sheet, it's certainly not too bad. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for Allkem (of which 1 is concerning!) you should know about.

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.

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.