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. We can see that Anglo Asian Mining PLC (LON:AAZ) does use debt in its business. 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. Part and parcel of capitalism is the process of ‘creative destruction’ where failed businesses are mercilessly liquidated by their bankers. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company’s use of debt, we first look at cash and debt together.
What Is Anglo Asian Mining’s Net Debt?
The image below, which you can click on for greater detail, shows that Anglo Asian Mining had debt of US$1.69m at the end of December 2019, a reduction from US$8.44m over a year. But on the other hand it also has US$22.9m in cash, leading to a US$21.2m net cash position.
A Look At Anglo Asian Mining’s Liabilities
Zooming in on the latest balance sheet data, we can see that Anglo Asian Mining had liabilities of US$33.0m due within 12 months and liabilities of US$39.8m due beyond that. Offsetting this, it had US$22.9m in cash and US$1.00m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$48.9m.
Anglo Asian Mining has a market capitalization of US$185.9m, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But it’s clear that we should definitely closely examine whether it can manage its debt without dilution. While it does have liabilities worth noting, Anglo Asian Mining also has more cash than debt, so we’re pretty confident it can manage its debt safely.
Also good is that Anglo Asian Mining grew its EBIT at 14% over the last year, further increasing its ability to manage debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Anglo Asian Mining’s ability to maintain a healthy balance sheet going forward. 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 Anglo Asian 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. Happily for any shareholders, Anglo Asian Mining actually produced more free cash flow than EBIT over the last three years. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.
While Anglo Asian Mining does have more liabilities than liquid assets, it also has net cash of US$21.2m. And it impressed us with free cash flow of US$20m, being 102% of its EBIT. So we don’t think Anglo Asian Mining’s use of debt is risky. 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. For instance, we’ve identified 2 warning signs for Anglo Asian Mining that 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. 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.