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 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. As with many other companies Medusa Mining Limited (ASX:MML) makes use of debt. But the real question is whether this debt is making the company risky.
When Is Debt A Problem?
Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. If things get really bad, the lenders can take control of the business. 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. When we think about a company's use of debt, we first look at cash and debt together.
What Is Medusa Mining's Net Debt?
You can click the graphic below for the historical numbers, but it shows that Medusa Mining had US$5.72m of debt in December 2019, down from US$7.44m, one year before. However, its balance sheet shows it holds US$24.6m in cash, so it actually has US$18.9m net cash.
A Look At Medusa Mining's Liabilities
The latest balance sheet data shows that Medusa Mining had liabilities of US$19.4m due within a year, and liabilities of US$7.34m falling due after that. Offsetting these obligations, it had cash of US$24.6m as well as receivables valued at US$6.30m due within 12 months. So it actually has US$4.19m more liquid assets than total liabilities.
This surplus suggests that Medusa Mining has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Medusa Mining has more cash than debt is arguably a good indication that it can manage its debt safely.
It was also good to see that despite losing money on the EBIT line last year, Medusa Mining turned things around in the last 12 months, delivering and EBIT of US$45m. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Medusa Mining will need earnings to service that debt. 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. Looking at the most recent year, Medusa Mining recorded free cash flow of 38% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.
While it is always sensible to investigate a company's debt, in this case Medusa Mining has US$18.9m in net cash and a decent-looking balance sheet. So we are not troubled with Medusa Mining's debt use. 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. Be aware that Medusa Mining is showing 3 warning signs in our investment analysis , and 1 of those doesn't sit too well with us...
Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.
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