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David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital. 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 note that Atico Mining Corporation (CVE:ATY) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.
Why Does Debt Bring Risk?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
What Is Atico Mining's Net Debt?
You can click the graphic below for the historical numbers, but it shows that as of September 2019 Atico Mining had US$6.65m of debt, an increase on US$5.25m, over one year. But it also has US$7.22m in cash to offset that, meaning it has US$575.0k net cash.
A Look At Atico Mining's Liabilities
We can see from the most recent balance sheet that Atico Mining had liabilities of US$15.5m falling due within a year, and liabilities of US$21.4m due beyond that. On the other hand, it had cash of US$7.22m and US$3.83m worth of receivables due within a year. So it has liabilities totalling US$25.9m more than its cash and near-term receivables, combined.
Given this deficit is actually higher than the company's market capitalization of US$21.6m, we think shareholders really should watch Atico Mining's debt levels, like a parent watching their child ride a bike for the first time. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price. Atico Mining boasts net cash, so it's fair to say it does not have a heavy debt load, even if it does have very significant liabilities, in total.
In fact Atico Mining's saving grace is its low debt levels, because its EBIT has tanked 32% in the last twelve months. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Atico Mining'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.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Atico Mining 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 most recent three years, Atico Mining recorded free cash flow worth 72% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.
While Atico Mining does have more liabilities than liquid assets, it also has net cash of US$575.0k. The cherry on top was that in converted 72% of that EBIT to free cash flow, bringing in US$6.5m. So although we see some areas for improvement, we're not too worried about Atico Mining's balance sheet. In light of our reservations about the company's balance sheet, it seems sensible to check if insiders have been selling shares recently.
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.
If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. 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. Simply Wall St has no position in the stocks mentioned.
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