Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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 can see that Atico Mining Corporation (CVE:ATY) does use debt in its business. But should shareholders be worried about its use of debt?
What Risk Does Debt Bring?
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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. When we think about a company's use of debt, we first look at cash and debt together.
What Is Atico Mining's Net Debt?
As you can see below, at the end of June 2020, Atico Mining had US$6.32m of debt, up from none a year ago. Click the image for more detail. However, it does have US$8.93m in cash offsetting this, leading to net cash of US$2.61m.
How Healthy Is Atico Mining's Balance Sheet?
According to the last reported balance sheet, Atico Mining had liabilities of US$12.6m due within 12 months, and liabilities of US$20.6m due beyond 12 months. Offsetting these obligations, it had cash of US$8.93m as well as receivables valued at US$3.97m due within 12 months. So its liabilities total US$20.3m more than the combination of its cash and short-term receivables.
This deficit isn't so bad because Atico Mining is worth US$35.8m, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt. While it does have liabilities worth noting, Atico Mining also has more cash than debt, so we're pretty confident it can manage its debt safely.
The good news is that Atico Mining has increased its EBIT by 7.0% over twelve months, which should ease any concerns about debt repayment. There's no doubt that we learn most about debt from the balance sheet. 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're focused on the future you can check out this free report showing analyst profit forecasts.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Atico Mining has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. During the last three years, Atico Mining generated free cash flow amounting to a very robust 82% of its EBIT, more than we'd expect. That positions it well to pay down debt if desirable to do so.
While Atico Mining does have more liabilities than liquid assets, it also has net cash of US$2.61m. The cherry on top was that in converted 82% of that EBIT to free cash flow, bringing in US$4.9m. So we don't have any problem with Atico Mining's use of debt. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. For instance, we've identified 2 warning signs for Atico Mining that you should be aware of.
At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.
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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