Here's Why Eagle Mountain Mining (ASX:EM2) Can Afford Some 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.' 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. Importantly, Eagle Mountain Mining Limited (ASX:EM2) does carry debt. But the more important question is: how much risk is that debt creating?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Eagle Mountain Mining

How Much Debt Does Eagle Mountain Mining Carry?

The image below, which you can click on for greater detail, shows that at December 2020 Eagle Mountain Mining had debt of AU$11.9m, up from AU$10.7m in one year. However, it does have AU$2.35m in cash offsetting this, leading to net debt of about AU$9.59m.

A Look At Eagle Mountain Mining's Liabilities

Zooming in on the latest balance sheet data, we can see that Eagle Mountain Mining had liabilities of AU$1.96m due within 12 months and liabilities of AU$10.7m due beyond that. On the other hand, it had cash of AU$2.35m and AU$178.8k worth of receivables due within a year. So its liabilities total AU$10.1m more than the combination of its cash and short-term receivables.

Given Eagle Mountain Mining has a market capitalization of AU$135.6m, it's hard to believe these liabilities pose much threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Eagle Mountain Mining will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Since Eagle Mountain Mining has no significant operating revenue, shareholders probably hope it will develop a valuable new mine before too long.

Caveat Emptor

Importantly, Eagle Mountain Mining had an earnings before interest and tax (EBIT) loss over the last year. To be specific the EBIT loss came in at AU$6.9m. When we look at that and recall the liabilities on its balance sheet, relative to cash, it seems unwise to us for the company to have any debt. So we think its balance sheet is a little strained, though not beyond repair. Another cause for caution is that is bled AU$5.7m in negative free cash flow over the last twelve months. So suffice it to say we do consider the stock to be risky. 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. For instance, we've identified 4 warning signs for Eagle Mountain Mining (3 are concerning) you should be aware of.

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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