We Think Capricorn Metals (ASX:CMM) Can Stay On Top Of Its Debt

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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. As with many other companies Capricorn Metals Ltd (ASX:CMM) makes use of debt. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

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. 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. 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 examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Capricorn Metals

What Is Capricorn Metals's Net Debt?

The chart below, which you can click on for greater detail, shows that Capricorn Metals had AU$50.7m in debt in December 2023; about the same as the year before. But it also has AU$157.8m in cash to offset that, meaning it has AU$107.1m net cash.

How Healthy Is Capricorn Metals' Balance Sheet?

We can see from the most recent balance sheet that Capricorn Metals had liabilities of AU$48.4m falling due within a year, and liabilities of AU$262.7m due beyond that. Offsetting these obligations, it had cash of AU$157.8m as well as receivables valued at AU$2.99m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by AU$150.4m.

Since publicly traded Capricorn Metals shares are worth a total of AU$1.99b, it seems unlikely that this level of liabilities would be a major threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. Despite its noteworthy liabilities, Capricorn Metals boasts net cash, so it's fair to say it does not have a heavy debt load!

It is just as well that Capricorn Metals's load is not too heavy, because its EBIT was down 44% over the last year. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Capricorn Metals can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Capricorn 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. During the last three years, Capricorn Metals produced sturdy free cash flow equating to 57% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Summing Up

While it is always sensible to look at a company's total liabilities, it is very reassuring that Capricorn Metals has AU$107.1m in net cash. So we are not troubled with Capricorn Metals's debt use. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For example - Capricorn Metals has 2 warning signs we think you should be aware of.

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.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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.