David Iben put it well when he said, “Volatility is not a risk we care about. What we care about is preventing permanent loss of capital.’ It seems the smart money knows that debt – which usually comes with bankruptcies – is a very important factor when you assess how risky a company is. important, Limited Mineral Resources (ASX:MIN) does bear debt. But is this debt a concern for shareholders?
When is debt a problem?
Debt helps a company until the company struggles to pay it off, either with new capital or free cash flow. An essential part of capitalism is the process of ‘creative destruction’, in which failed companies are mercilessly liquidated by their bankers. However, a more frequent (but still costly) event is a company having to issue shares at spot prices, permanently diluting shareholders, just to bolster its balance sheet. However, by replacing dilution, debt can be an extremely good tool for companies that need capital to invest in high-yield growth. The first thing to do when considering how much debt a company uses is to look at its cash and debt together.
How Much Debt Do Mineral Resources Carry?
The image below, which you can click for more details, shows Mineral Resources had debt of AU$920.9m at the end of December 2020, down from AU$992.8m over one year. But it also has AU$1.11 billion in cash to offset that, meaning it has AU$192.5 million in net cash.
How healthy is the balance of mineral resources?
From the most recent balance sheet, we can see that Mineral Resources had liabilities of AU$645.7m that fell due within one year and liabilities of AU$1.41b that fell after that. This was offset by AU$1.11 billion in cash and AU$355.9 million in receivables due within 12 months. So his liabilities outweigh AU$589.7 million against the sum of his cash and receivables.
Of course, Mineral Resources has a market cap of AU$9.25 billion, so these liabilities are probably manageable. However, we think it’s worth keeping an eye on the strength of the balance sheet as it can change over time. While it has notable liabilities, Mineral Resources also has more money than debt, so we’re pretty sure it can manage its debt safely.
In fact, Mineral Resources grew its EBIT by 121% last year, which is an impressive improvement. That boost will make it even easier to pay off debt in the future. There is no doubt that we learn the most about debt from the balance sheet. But it is primarily future income that will determine Mineral Resources’ ability to maintain a healthy balance sheet in the future. So if you’re focused on the future, check this out free Analyst earnings forecast report.
Finally, a company can only pay off debt with cold hard cash, not accounting profits. While Mineral Resources has net cash on its balance sheet, it’s worth looking at its ability to convert earnings before interest and tax (EBIT) into free cash flow to help us understand how quickly it’s building that cash. (or erodes) balance. Over the past three years, Mineral Resources has burned a lot of money. While investors undoubtedly expect a turnaround in that situation over time, this clearly means that using debt is more risky.
While it is always wise to look at a company’s total liabilities, it is very reassuring that Mineral Resources has AU$192.5 million in net cash. And we liked the look of last year’s 121% yoy EBIT growth. So we’re not bothered by Mineral Resources’ debt use. There is no doubt that we learn the most about debt from the balance sheet. But in the end, any business can contain risks that exist off-balance sheet. These risks can be difficult to spot. Every company has them and we’ve seen them 5 Mineral Resource Warning Signs (of which 2 are concerning!) that you should be aware of.
At the end of the day, it’s often better to focus on companies that are free of net debt. You can access our special list of such companies (all with a track record of earnings growth). It is free.
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