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

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.' 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 Capricorn Metals Ltd (ASX:CMM) does have debt on its balance sheet. But is this debt a concern to shareholders?

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. 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 Capricorn Metals

How Much Debt Does Capricorn Metals Carry?

You can click the graphic below for the historical numbers, but it shows that Capricorn Metals had AU$50.6m of debt in June 2023, down from AU$65.4m, one year before. But on the other hand it also has AU$107.4m in cash, leading to a AU$56.8m net cash position.

How Healthy Is Capricorn Metals' Balance Sheet?

According to the last reported balance sheet, Capricorn Metals had liabilities of AU$44.7m due within 12 months, and liabilities of AU$235.2m due beyond 12 months. On the other hand, it had cash of AU$107.4m and AU$2.15m worth of receivables due within a year. So it has liabilities totalling AU$170.4m more than its cash and near-term receivables, combined.

Since publicly traded Capricorn Metals shares are worth a total of AU$1.81b, it seems unlikely that this level of liabilities would be a major threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. While it does have liabilities worth noting, Capricorn Metals also has more cash than debt, so we're pretty confident it can manage its debt safely.

In fact Capricorn Metals's saving grace is its low debt levels, because its EBIT has tanked 60% in the last twelve months. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Capricorn Metals can strengthen its balance sheet over time. 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. 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. Over the last two years, Capricorn Metals recorded free cash flow worth a fulsome 99% of its EBIT, which is stronger than we'd usually expect. That puts it in a very strong position to pay down debt.

Summing Up

While it is always sensible to look at a company's total liabilities, it is very reassuring that Capricorn Metals has AU$56.8m in net cash. And it impressed us with free cash flow of AU$105m, being 99% of its EBIT. So we don't have any problem with Capricorn Metals's use of debt. 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 example, we've discovered 2 warning signs for Capricorn Metals that you should be aware of before investing here.

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.

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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.