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 Medusa Mining Limited (ASX:MML) does use debt in its business. But the real question is whether this debt is making the company risky.
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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
What Is Medusa Mining's Debt?
As you can see below, at the end of June 2019, Medusa Mining had US$6.83m of debt, up from US$6.51m a year ago. Click the image for more detail. But it also has US$18.1m in cash to offset that, meaning it has US$11.3m net cash.
A Look At Medusa Mining's Liabilities
The latest balance sheet data shows that Medusa Mining had liabilities of US$21.5m due within a year, and liabilities of US$6.87m falling due after that. Offsetting these obligations, it had cash of US$18.1m as well as receivables valued at US$5.19m due within 12 months. So it has liabilities totalling US$5.03m more than its cash and near-term receivables, combined.
Given Medusa Mining has a market capitalization of US$115.6m, it's hard to believe these liabilities pose much threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. Despite its noteworthy liabilities, Medusa Mining boasts net cash, so it's fair to say it does not have a heavy debt load!
Although Medusa Mining made a loss at the EBIT level, last year, it was also good to see that it generated US$31m in EBIT over the last twelve months. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Medusa Mining's earnings that will influence how the balance sheet holds up in the future. 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.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Medusa 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. In the last year, Medusa Mining's free cash flow amounted to 41% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.
We could understand if investors are concerned about Medusa Mining's liabilities, but we can be reassured by the fact it has has net cash of US$11.3m. So we are not troubled with Medusa Mining's debt use. We'd be motivated to research the stock further if we found out that Medusa Mining 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.
If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.
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