Ann: Quarterly Activities/Appendix 5B Cash Flow Report, page-3

Another Quarterly, still no mining!

AuditorsAre Concerned About Korab Resources (ASX:KOR)

Theharsh reality for Korab Resources Limited shareholders is that its auditors, Armada Audit & Assurance Pty Ltd, expressed doubts about its ability to continue as a going concern, in its reported results to June 2022. This means that, based on the financial results to that date, the company arguably should raise capital, or otherwise strengthen the balance sheet, as soon as possible.

Ifthe company does have to issue more shares, potential investors will be sure toconsider how desperate it is for capital. So current risks on the balance sheetcould have a big impact on how shareholders fare from here. The biggest concernwe would have is the company's debt, since its lenders might force the companyinto administration if it cannot repay them.

HowMuch Debt Does Korab Resources Carry?

Thechart below, which you can click on for greater detail, shows that KorabResources had AU$2.83m in debt in June 2022; about the same as the year before.However, it does have AU$815.8k in cash offsetting this, leading to net debt ofabout AU$2.02m.

HowHealthy Is Korab Resources' Balance Sheet?

Thelatest balance sheet data shows that Korab Resources had liabilities ofAU$280.8k due within a year, and liabilities of AU$2.72m falling due afterthat. Offsetting these obligations, it had cash of AU$815.8k as well asreceivables valued at AU$41.1k due within 12 months. So it has liabilitiestotalling AU$2.14m more than its cash and near-term receivables,combined.

GivenKorab Resources has a market capitalization of AU$11.4m, it's hard to believethese liabilities pose much threat. Having said that, it's clear that we shouldcontinue to monitor its balance sheet, lest it change for the worse.

Wemeasure a company's debt load relative to its earnings power by looking at itsnet debt divided by its earnings before interest, tax, depreciation, andamortization (EBITDA) and by calculating how easily its earnings beforeinterest and tax (EBIT) cover its interest expense (interest cover). This way,we consider both the absolute quantum of the debt, as well as the interestrates paid on it.

Whilewe wouldn't worry about Korab Resources's net debt to EBITDA ratio of 3.2, wethink its super-low interest cover of 1.1 times is a sign of high leverage. Inlarge part that's due to the company's significant depreciation andamortisation charges, which arguably mean its EBITDA is a very generous measureof earnings, and its debt may be more of a burden than it first appears. Itseems clear that the cost of borrowing money is negatively impacting returnsfor shareholders, of late. On a lighter note, we note that Korab Resources grewits EBIT by 30% in the last year. If it can maintain that kind of improvement,its debt load will begin to melt away like glaciers in a warming world. Thebalance sheet is clearly the area to focus on when you are analysing debt. Butyou can't view debt in total isolation; since Korab Resources will needearnings to service that debt. So when considering debt, it's definitely worthlooking at the earnings trend.

Finally,a company can only pay off debt with cold hard cash, not accounting profits. Sowe always check how much of that EBIT is translated into free cash flow. Duringthe last three years, Korab Resources burned a lot of cash. While investors areno doubt expecting a reversal of that situation in due course, it clearly doesmean its use of debt is more risky.

The View

While Korab Resources's interest cover makes uscautious about it, its track record of converting EBIT to free cash flow is nobetter. But at least its EBIT growth rate is a gleaming silver lining to thoseclouds. We think that Korab Resources's debt does make it a bit risky, afterconsidering the aforementioned data points together. Not all risk is bad, as itcan boost share price returns if it pays off, but this debt risk is worthkeeping in mind. Some investors may be interested in buying high risk stocks atthe right price, but we prefer to avoid a company after its auditor hasexpressed any uncertainty about its ability to continue as a going concern. Weprefer to invest in companies that ensure the balance sheet remains healthierthan that. When analysing debt levels, the balance sheet is the obvious placeto start. But ultimately, every company can contain risks that exist outside ofthe balance sheet.