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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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. Importantly, Medusa Mining Limited (ASX:MML) does carry debt. But the more important question is: how much risk is that debt creating?
When Is Debt Dangerous?
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. 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 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 Net Debt?
The image below, which you can click on for greater detail, shows that Medusa Mining had debt of US$5.75m at the end of June 2020, a reduction from US$6.83m over a year. However, it does have US$38.9m in cash offsetting this, leading to net cash of US$33.1m.
How Strong Is Medusa Mining's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Medusa Mining had liabilities of US$22.5m due within 12 months and liabilities of US$9.58m due beyond that. Offsetting these obligations, it had cash of US$38.9m as well as receivables valued at US$9.68m due within 12 months. So it can boast US$16.5m more liquid assets than total liabilities.
This short term liquidity is a sign that Medusa Mining could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that Medusa Mining has more cash than debt is arguably a good indication that it can manage its debt safely.
Another good sign is that Medusa Mining has been able to increase its EBIT by 23% in twelve months, making it easier to pay down debt. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Medusa Mining 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.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Medusa 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 two years, Medusa Mining recorded free cash flow worth 60% 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 it is always sensible to investigate a company's debt, in this case Medusa Mining has US$33.1m in net cash and a decent-looking balance sheet. And we liked the look of last year's 23% year-on-year EBIT growth. So we don't think Medusa Mining's use of debt is risky. We'd be very excited to see if Medusa Mining insiders have been snapping up shares. If you are too, then click on this link right now to take a (free) peek at our list of reported insider transactions.
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.
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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