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Is Iluka Resources (ASX:ILU) A Risky Investment?

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We can see that Iluka Resources Limited (ASX:ILU) does use debt in its business. But should shareholders be worried about its use of debt?

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. If things get really bad, the lenders can take control of the business. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Iluka Resources

How Much Debt Does Iluka Resources Carry?

The image below, which you can click on for greater detail, shows that Iluka Resources had debt of AU$88.2m at the end of June 2020, a reduction from AU$191.4m over a year. But it also has AU$150.3m in cash to offset that, meaning it has AU$62.1m net cash.

debt-equity-history-analysis
debt-equity-history-analysis

A Look At Iluka Resources's Liabilities

According to the last reported balance sheet, Iluka Resources had liabilities of AU$367.8m due within 12 months, and liabilities of AU$817.0m due beyond 12 months. Offsetting this, it had AU$150.3m in cash and AU$125.2m in receivables that were due within 12 months. So it has liabilities totalling AU$909.3m more than its cash and near-term receivables, combined.

Iluka Resources has a market capitalization of AU$4.14b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt. Despite its noteworthy liabilities, Iluka Resources boasts net cash, so it's fair to say it does not have a heavy debt load!

But the bad news is that Iluka Resources has seen its EBIT plunge 20% in the last twelve months. If that rate of decline in earnings continues, the company could find itself in a tight spot. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Iluka Resources can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Iluka 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. During the last three years, Iluka Resources produced sturdy free cash flow equating to 55% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Summing up

While Iluka Resources does have more liabilities than liquid assets, it also has net cash of AU$62.1m. So we don't have any problem with Iluka Resources's use of debt. We'd be motivated to research the stock further if we found out that Iluka Resources insiders have bought shares recently. If you would too, then you're in luck, since today we're sharing our list of reported insider transactions for free.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

This article by Simply Wall St is general in nature. 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.

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