Sandfire Resources (ASX:SFR) Seems To Use Debt Rather Sparingly

Simply Wall St

Sat, Apr 2, 2022, 10:14 PM 4 min read

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. We note that Sandfire Resources Limited (ASX:SFR) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

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. If things get really bad, the lenders can take control of the business. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for Sandfire Resources

What Is Sandfire Resources's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of December 2021 Sandfire Resources had US$145.0m of debt, an increase on none, over one year. But on the other hand it also has US$1.20b in cash, leading to a US$1.06b net cash position.

debt-equity-history-analysis — ASX:SFR Debt to Equity History April 2nd 2022

A Look At Sandfire Resources' Liabilities

According to the last reported balance sheet, Sandfire Resources had liabilities of US$294.2m due within 12 months, and liabilities of US$64.6m due beyond 12 months. On the other hand, it had cash of US$1.20b and US$16.7m worth of receivables due within a year. So it can boast US$859.6m more liquid assets than total liabilities.

This surplus liquidity suggests that Sandfire Resources' balance sheet could take a hit just as well as Homer Simpson's head can take a punch. With this in mind one could posit that its balance sheet means the company is able to handle some adversity. Succinctly put, Sandfire Resources boasts net cash, so it's fair to say it does not have a heavy debt load!

In addition to that, we're happy to report that Sandfire Resources has boosted its EBIT by 56%, thus reducing the spectre of future debt repayments. 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 Sandfire Resources's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Sandfire 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. Over the last three years, Sandfire Resources actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Sandfire Resources has net cash of US$1.06b, as well as more liquid assets than liabilities. And it impressed us with free cash flow of US$225m, being 104% of its EBIT. At the end of the day we're not concerned about Sandfire Resources's debt. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. For example Sandfire Resources has 4 warning signs (and 2 which make us uncomfortable) we think you should know about.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.