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Is Rainbow Rare Earths (LON:RBW) Using Too Much Debt?

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Warren Buffett famously said, 'Volatility is far from synonymous with risk.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We can see that Rainbow Rare Earths Limited (LON:RBW) does use debt in its business. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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.

See our latest analysis for Rainbow Rare Earths

How Much Debt Does Rainbow Rare Earths Carry?

The image below, which you can click on for greater detail, shows that at December 2020 Rainbow Rare Earths had debt of US$1.71m, up from US$817.0k in one year. But on the other hand it also has US$2.49m in cash, leading to a US$784.0k net cash position.

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

A Look At Rainbow Rare Earths' Liabilities

The latest balance sheet data shows that Rainbow Rare Earths had liabilities of US$1.73m due within a year, and liabilities of US$808.0k falling due after that. On the other hand, it had cash of US$2.49m and US$630.0k worth of receivables due within a year. So it can boast US$591.0k more liquid assets than total liabilities.

This state of affairs indicates that Rainbow Rare Earths' balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So it's very unlikely that the US$102.3m company is short on cash, but still worth keeping an eye on the balance sheet. Simply put, the fact that Rainbow Rare Earths has more cash than debt is arguably a good indication that it can manage its debt safely. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Rainbow Rare Earths will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

In the last year Rainbow Rare Earths wasn't profitable at an EBIT level, but managed to grow its revenue by 70%, to US$793k. Shareholders probably have their fingers crossed that it can grow its way to profits.

So How Risky Is Rainbow Rare Earths?

Statistically speaking companies that lose money are riskier than those that make money. And the fact is that over the last twelve months Rainbow Rare Earths lost money at the earnings before interest and tax (EBIT) line. Indeed, in that time it burnt through US$3.5m of cash and made a loss of US$2.0m. With only US$784.0k on the balance sheet, it would appear that its going to need to raise capital again soon. Rainbow Rare Earths's revenue growth shone bright over the last year, so it may well be in a position to turn a profit in due course. By investing before those profits, shareholders take on more risk in the hope of bigger rewards. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 5 warning signs for Rainbow Rare Earths (3 can't be ignored!) that you should be aware of before investing here.

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.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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