Is Eagle Mountain Mining (ASX:EM2) Using Too Much 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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We note that Eagle Mountain Mining Limited (ASX:EM2) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

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. 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Eagle Mountain Mining

What Is Eagle Mountain Mining's Debt?

The image below, which you can click on for greater detail, shows that at June 2021 Eagle Mountain Mining had debt of AU$12.3m, up from AU$10.9m in one year. On the flip side, it has AU$9.12m in cash leading to net debt of about AU$3.23m.

How Strong Is Eagle Mountain Mining's Balance Sheet?

According to the last reported balance sheet, Eagle Mountain Mining had liabilities of AU$2.73m due within 12 months, and liabilities of AU$11.4m due beyond 12 months. On the other hand, it had cash of AU$9.12m and AU$162.8k worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by AU$4.81m.

Given Eagle Mountain Mining has a market capitalization of AU$161.8m, it's hard to believe these liabilities pose much threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. 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 when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Given its lack of meaningful operating revenue, investors are probably hoping that Eagle Mountain Mining finds some valuable resources, before it runs out of money.

Caveat Emptor

Importantly, Eagle Mountain Mining had an earnings before interest and tax (EBIT) loss over the last year. Its EBIT loss was a whopping AU$19m. Considering that alongside the liabilities mentioned above does not give us much confidence that company should be using so much debt. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. However, it doesn't help that it burned through AU$10m of cash over the last year. So suffice it to say we consider the stock very risky. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 5 warning signs for Eagle Mountain Mining (4 can't be ignored) 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.

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.

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