U.S. Markets closed

We Think Cameco (TSE:CCO) Can Stay On Top Of Its Debt

Simply Wall St

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, Cameco Corporation (TSE:CCO) does carry debt. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for Cameco

What Is Cameco's Debt?

The chart below, which you can click on for greater detail, shows that Cameco had CA$1.50b in debt in June 2019; about the same as the year before. On the flip side, it has CA$1.11b in cash leading to net debt of about CA$383.1m.

TSX:CCO Historical Debt, September 9th 2019

How Strong Is Cameco's Balance Sheet?

The latest balance sheet data shows that Cameco had liabilities of CA$823.4m due within a year, and liabilities of CA$2.31b falling due after that. On the other hand, it had cash of CA$1.11b and CA$215.1m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by CA$1.80b.

This deficit isn't so bad because Cameco is worth CA$4.72b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

While Cameco's low debt to EBITDA ratio of 0.66 suggests only modest use of debt, the fact that EBIT only covered the interest expense by 6.5 last year does give us pause. So we'd recommend keeping a close eye on the impact financing costs are having on the business. Better yet, Cameco grew its EBIT by 135% last year, which is an impressive improvement. If maintained that growth will make the debt even more manageable in the years ahead. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Cameco's ability to maintain a healthy balance sheet going forward. 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. So we always check how much of that EBIT is translated into free cash flow. Over the last three years, Cameco actually produced more free cash flow than EBIT. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Our View

Happily, Cameco's impressive conversion of EBIT to free cash flow implies it has the upper hand on its debt. And the good news does not stop there, as its EBIT growth rate also supports that impression! Zooming out, Cameco seems to use debt quite reasonably; and that gets the nod from us. After all, sensible leverage can boost returns on equity. Of course, we wouldn't say no to the extra confidence that we'd gain if we knew that Cameco insiders have been buying shares: if you're on the same wavelength, you can find out if insiders are buying by clicking this link.

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.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. 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. Simply Wall St has no position in the stocks mentioned. Thank you for reading.