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Is Karora Resources (TSE:KRR) A Risky Investment?

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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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We can see that Karora Resources Inc. (TSE:KRR) does use debt in its business. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free 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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Karora Resources

How Much Debt Does Karora Resources Carry?

As you can see below, Karora Resources had CA$33.9m of debt at September 2021, down from CA$38.9m a year prior. However, its balance sheet shows it holds CA$90.8m in cash, so it actually has CA$56.9m net cash.

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

A Look At Karora Resources' Liabilities

Zooming in on the latest balance sheet data, we can see that Karora Resources had liabilities of CA$50.9m due within 12 months and liabilities of CA$106.5m due beyond that. On the other hand, it had cash of CA$90.8m and CA$4.92m worth of receivables due within a year. So its liabilities total CA$61.6m more than the combination of its cash and short-term receivables.

Since publicly traded Karora Resources shares are worth a total of CA$598.7m, it seems unlikely that this level of liabilities would be a major threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. While it does have liabilities worth noting, Karora Resources also has more cash than debt, so we're pretty confident it can manage its debt safely.

In addition to that, we're happy to report that Karora Resources has boosted its EBIT by 35%, thus reducing the spectre of future debt repayments. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Karora Resources's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Karora Resources 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. In the last three years, Karora Resources created free cash flow amounting to 4.4% of its EBIT, an uninspiring performance. That limp level of cash conversion undermines its ability to manage and pay down debt.

Summing up

Although Karora Resources's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of CA$56.9m. And we liked the look of last year's 35% year-on-year EBIT growth. So we are not troubled with Karora Resources's debt use. 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. We've identified 4 warning signs with Karora Resources (at least 1 which is concerning) , and understanding them should be part of your investment process.

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.

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