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The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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 Maverix Metals Inc. (TSE:MMX) does use debt in its business. But should shareholders be worried about its use of debt?
Why Does Debt Bring Risk?
Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.
What Is Maverix Metals's Net Debt?
You can click the graphic below for the historical numbers, but it shows that Maverix Metals had US$34.9m of debt in September 2020, down from US$51.0m, one year before. But it also has US$42.3m in cash to offset that, meaning it has US$7.48m net cash.
How Healthy Is Maverix Metals' Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Maverix Metals had liabilities of US$12.9m due within 12 months and liabilities of US$35.0m due beyond that. Offsetting this, it had US$42.3m in cash and US$11.7m in receivables that were due within 12 months. So it actually has US$6.19m more liquid assets than total liabilities.
Having regard to Maverix Metals' size, it seems that its liquid assets are well balanced with its total liabilities. So while it's hard to imagine that the US$750.6m company is struggling for cash, we still think it's worth monitoring its balance sheet. Succinctly put, Maverix Metals boasts net cash, so it's fair to say it does not have a heavy debt load!
Shareholders should be aware that Maverix Metals's EBIT was down 42% last year. If that earnings trend continues then paying off its debt will be about as easy as herding cats on to a roller coaster. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Maverix Metals can strengthen its balance sheet over time. 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 Maverix Metals 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. Over the last three years, Maverix Metals saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.
While it is always sensible to investigate a company's debt, in this case Maverix Metals has US$7.48m in net cash and a decent-looking balance sheet. Despite the cash, we do find Maverix Metals's EBIT growth rate concerning, so we're not particularly comfortable with the stock. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. To that end, you should be aware of the 3 warning signs we've spotted with Maverix Metals .
When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.
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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