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.’ So it seems the smart money knows that debt – which is usually involved in bankruptcies – is a very important factor, when you assess how risky a company is. As with many other companies Pilbara Minerals Limited (ASX:PLS) makes use of debt. But is this debt a concern to shareholders?
What Risk Does Debt Bring?
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. Ultimately, if the company can’t fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Having said that, the most common situation is where a company manages its debt reasonably well – and to its own advantage. When we think about a company’s use of debt, we first look at cash and debt together.
As you can see below, Pilbara Minerals had AU$134.3m of debt, at June 2019, which is about the same the year before. You can click the chart for greater detail. However, it does have AU$63.6m in cash offsetting this, leading to net debt of about AU$70.7m.
ASX:PLS Historical Debt, August 24th 2019How Strong Is Pilbara Minerals’s Balance Sheet?
We can see from the most recent balance sheet that Pilbara Minerals had liabilities of AU$59.0m falling due within a year, and liabilities of AU$146.6m due beyond that. On the other hand, it had cash of AU$63.6m and AU$11.1m worth of receivables due within a year. So its liabilities total AU$131.0m more than the combination of its cash and short-term receivables.
Of course, Pilbara Minerals has a market capitalization of AU$768.6m, 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. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Pilbara Minerals’s ability to maintain a healthy balance sheet going forward. So if you’re focused on the future you can check out this.
In the last year Pilbara Minerals managed to grow its revenue by 320%, to AU$43m. When it comes to revenue growth, that’s like nailing the game winning 3-pointer!
Caveat Emptor
Even though Pilbara Minerals managed to grow its top line quite deftly, the cold hard truth is that it is losing money on the EBIT line. Indeed, it lost AU$19m at the EBIT level. Considering that alongside the liabilities mentioned above does not give us much confidence that company should be using so much debt. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. Another cause for caution is that is bled AU$189m in negative free cash flow over the last twelve months. So suffice it to say we consider the stock very risky.
