David Iben put it right when he said: “Volatility is not a risk that is close to our hearts. What matters to us is to avoid the permanent loss of capital. It is natural to consider a company’s balance sheet when considering how risky it is, as debt is often involved when a business collapses. Mostly, Newton Resources Ltd (HKG: 1231) is in debt. But should shareholders be concerned about its use of debt?
When is debt dangerous?
Debt helps a business until it struggles to pay it off, either with new capital or with free cash flow. If things really go wrong, lenders can take over the business. While it’s not too common, we often see indebted companies continually diluting shareholders because lenders are forcing them to raise capital at a difficult price. Of course, many companies use debt to finance growth without any negative consequences. When we look at debt levels, we first look at cash and debt levels, together.
See our latest analysis for Newton resources
What is Newton Resources’ debt?
You can click on the graph below for historical numbers, but it shows Newton Resources had $ 20.2 million in debt as of December 2020, up from $ 74.5 million a year earlier. However, it has US $ 17.4 million in cash, which translates into net debt of around US $ 2.80 million.
How healthy is Newton Resources’ balance sheet?
The latest balance sheet data shows that Newton Resources had liabilities of US $ 103.5 million due within one year, and liabilities of US $ 101.0 thousand due thereafter. In return, he had US $ 17.4 million in cash and US $ 96.5 million in receivables due within 12 months. So he actually has US $ 10.3 million After liquid assets than total liabilities.
This surplus suggests that Newton Resources has a prudent balance sheet and could probably eliminate its debt without too much difficulty. But either way, Newton Resources has virtually no net debt, so it’s fair to say that it doesn’t have heavy debt!
We use two main ratios to tell us about leverage versus earnings levels. The first is net debt divided by earnings before interest, taxes, depreciation and amortization (EBITDA), while the second is the number of times its profit before interest and taxes (EBIT) covers its interest expense (or its coverage of interest, for short). In this way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.
Newton Resources has a very low debt to EBITDA ratio of 0.73, so it is strange to see low interest coverage as last year’s EBIT was only 1.5 times the interest expense. So while we’re not necessarily alarmed, we think his debt is far from trivial. Fortunately, Newton Resources is increasing its EBIT faster than former Australian Prime Minister Bob Hawke lowers a glass of a meter, enjoying an 185% gain in the past twelve months. There is no doubt that we learn the most about debt from the balance sheet. But it is Newton Resources’ profits that will influence the way the balance sheet looks in the future. So when you consider debt, it’s really worth looking at the profit trend. Click here for an interactive snapshot.
Finally, a business needs free cash flow to repay its debt; accounting profits do not reduce it. It is therefore worth checking to what extent this EBIT is supported by free cash flow. Over the past two years, Newton Resources has experienced substantial negative free cash flow, in total. While this may be the result of spending for growth, it makes debt much riskier.
Our point of view
Newton Resources’ conversion of EBIT to free cash flow was a real drawback for this analysis, as was its interest coverage. But like a ballerina finishing on a perfect spin, she has no trouble growing her EBIT. Given this range of data points, we believe Newton Resources is well positioned to manage its debt levels. That said, the burden is heavy enough that we recommend that all shareholders watch it closely. The balance sheet is clearly the area to focus on when analyzing debt. But at the end of the day, every business can contain risks that exist off the balance sheet. For example, we have identified 2 warning signs for Newton Resources (1 is significant) that you should be aware of.
At the end of the day, sometimes it’s easier to focus on businesses that don’t even need debt. Readers can access a list of growth stocks with zero net debt 100% free, at present.
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