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. Importantly, Fortune Minerals Limited (TSE:FT) does carry debt. But is this debt a concern to shareholders?
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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.
What Is Fortune Minerals's Net Debt?
As you can see below, at the end of September 2019, Fortune Minerals had CA$8.32m of debt, up from CA$7.16m a year ago. Click the image for more detail. However, it also had CA$1.93m in cash, and so its net debt is CA$6.39m.
How Strong Is Fortune Minerals's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Fortune Minerals had liabilities of CA$143.9k due within 12 months and liabilities of CA$12.1m due beyond that. Offsetting this, it had CA$1.93m in cash and CA$58.9k in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CA$10.2m.
While this might seem like a lot, it is not so bad since Fortune Minerals has a market capitalization of CA$24.3m, and so it could probably strengthen its balance sheet by raising capital if it needed to. But it's clear that we should definitely closely examine whether it can manage its debt without dilution. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Fortune Minerals will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.
Since Fortune Minerals has no significant operating revenue, shareholders probably hope it will develop a valuable new mine before too long.
Importantly, Fortune Minerals had negative earnings before interest and tax (EBIT), over the last year. Indeed, it lost CA$1.6m at the EBIT level. When we look at that and recall the liabilities on its balance sheet, relative to cash, it seems unwise to us for the company to have any debt. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. However, it doesn't help that it burned through CA$4.1m of cash over the last year. So suffice it to say we consider the stock very risky. When I consider a company to be a bit risky, I think it is responsible to check out whether insiders have been reporting any share sales. Luckily, you can click here ito see our graphic depicting Fortune Minerals insider transactions.
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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