Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett said “volatility is far from synonymous with risk.” It’s natural to consider a company’s balance sheet when looking at its riskiness, as debt is often involved when a company fails. We can see that Lynas Rare Earths Limited (ASX:LYC) uses debt in its business. But should shareholders worry about its use of debt?
Why is debt risky?
Generally speaking, debt only becomes a real problem when a company cannot easily repay it, either by raising capital or with its own cash flow. In the worst case, a company can go bankrupt if it cannot pay its creditors. 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, debt can be an important tool in businesses, especially capital-intensive businesses. When we look at debt levels, we first consider cash and debt levels, together.
Check out our latest analysis for Lynas Rare Earths
What is Lynas Rare Earths net debt?
You can click on the graph below for historical figures, but it shows that in June 2022, Lynas Rare Earths had a debt of A$186.8 million, an increase from A$171.1 million , over one year. However, he has A$965.6 million in cash to offset this, resulting in a net cash of A$778.8 million.
A Look at Lynas Rare Earths Responsibilities
Zooming in on the latest balance sheet data, we can see that Lynas Rare Earths had liabilities of A$123.6 million due within 12 months and liabilities of A$292.4 million due beyond. In compensation for these obligations, it had cash of 965.6 million Australian dollars as well as receivables valued at 109.9 million Australian dollars and payable within 12 months. So he actually has A$659.4 million After liquid assets than total liabilities.
This short-term liquidity is a sign that Lynas Rare Earths could probably repay its debt easily, as its balance sheet is far from stretched. In short, Lynas Rare Earths has a clean cash flow, so it’s fair to say that she doesn’t have a lot of debt!
Even more impressive is the fact that Lynas Rare Earths increased its EBIT by 236% year-over-year. This boost will make it even easier to pay off debt in the future. When analyzing debt levels, the balance sheet is the obvious starting point. But it is future earnings, more than anything, that will determine Lynas Rare Earths’ 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.
But our last consideration is also important, because a company cannot pay debt with paper profits; he needs cash. Although Lynas Rare Earths has net cash on its balance sheet, it’s still worth looking at its ability to convert earnings before interest and taxes (EBIT) to free cash flow, to help us understand how fast it’s growing. builds (or erodes) cash balance. Over the past two years, Lynas Rare Earths has produced strong free cash flow equivalent to 66% of its EBIT, which is what we expected. This cold hard cash allows him to reduce his debt whenever he wants.
While we sympathize with investors who find debt a concern, you should bear in mind that Lynas Rare Earths has net cash of A$778.8 million, as well as more liquid assets than liabilities. . And it has impressed us with its 236% EBIT growth over the past year. So we don’t think Lynas Rare Earths’ use of debt is risky. There is no doubt that we learn the most about debt from the balance sheet. But at the end of the day, every business can contain risks that exist outside of the balance sheet. Know that Lynas Rare Earths shows 1 warning sign in our investment analysis you should know…
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.
Feedback on this article? Concerned about content? Get in touch with us directly. You can also email the editorial team (at) Simplywallst.com.
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.
Valuation is complex, but we help make it simple.
Find out if Lynas Rare Earths is potentially overvalued or undervalued by viewing our full analysis, which includes fair value estimates, risks and warnings, dividends, insider trading and financial health.
See the free analysis