David Iben put it well when he said, ‘Volatility is not a risk we care about. What we care about is avoiding the 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. We note that Endeavour Mining Corporation (TSE:EDV) does have debt on its balance sheet. But should shareholders be worried about its use of debt?
Why Does Debt Bring Risk?
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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Having said that, the most common situation is where a company manages its debt reasonably well – and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
What Is Endeavour Mining’s Net Debt?
You can click the graphic below for the historical numbers, but it shows that as of March 2020 Endeavour Mining had US$756.8m of debt, an increase on US$594.1m, over one year. However, it does have US$359.0m in cash offsetting this, leading to net debt of about US$397.8m.
How Healthy Is Endeavour Mining’s Balance Sheet?
According to the last reported balance sheet, Endeavour Mining had liabilities of US$285.1m due within 12 months, and liabilities of US$898.5m due beyond 12 months. Offsetting these obligations, it had cash of US$359.0m as well as receivables valued at US$26.7m due within 12 months. So it has liabilities totalling US$797.9m more than its cash and near-term receivables, combined.
While this might seem like a lot, it is not so bad since Endeavour Mining has a market capitalization of US$2.58b, and so it could probably strengthen its balance sheet by raising capital if it needed to. However, it is still worthwhile taking a close look at its ability to pay off debt.
In order to size up a company’s debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.
Given net debt is only 0.90 times EBITDA, it is initially surprising to see that Endeavour Mining’s EBIT has low interest coverage of 2.5 times. So while we’re not necessarily alarmed we think that its debt is far from trivial. Pleasingly, Endeavour Mining is growing its EBIT faster than former Australian PM Bob Hawke downs a yard glass, boasting a 108% gain in the last twelve months. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Endeavour Mining’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.
Finally, a business needs free cash flow to pay off debt; accounting profits just don’t cut it. So it’s worth checking how much of that EBIT is backed by free cash flow. During the last three years, Endeavour Mining burned a lot of cash. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.
Endeavour Mining’s conversion of EBIT to free cash flow and interest cover definitely weigh on it, in our esteem. But its EBIT growth rate tells a very different story, and suggests some resilience. Looking at all the angles mentioned above, it does seem to us that Endeavour Mining is a somewhat risky investment as a result of its debt. That’s not necessarily a bad thing, since leverage can boost returns on equity, but it is something to be aware of. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that Endeavour Mining is showing 1 warning sign in our investment analysis , you should know about…
If you’re interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.
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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. Thank you for reading.