Would Focus Minerals (ASX:FML) Be Better Off With Less Debt?

Legendary fund manager Li Lu (who Charlie Munger backed) once said, '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. As with many other companies Focus Minerals Limited (ASX:FML) makes use of debt. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. 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 Focus Minerals

How Much Debt Does Focus Minerals Carry?

As you can see below, at the end of December 2020, Focus Minerals had AU$20.0m of debt, up from none a year ago. Click the image for more detail. On the flip side, it has AU$19.9m in cash leading to net debt of about AU$75.0k.

How Healthy Is Focus Minerals' Balance Sheet?

According to the last reported balance sheet, Focus Minerals had liabilities of AU$1.13m due within 12 months, and liabilities of AU$49.0m due beyond 12 months. Offsetting this, it had AU$19.9m in cash and AU$252.0k in receivables that were due within 12 months. So its liabilities total AU$30.0m more than the combination of its cash and short-term receivables.

While this might seem like a lot, it is not so bad since Focus Minerals has a market capitalization of AU$52.1m, 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. Carrying virtually no net debt, Focus Minerals has a very light debt load indeed. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Focus Minerals 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.

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

Caveat Emptor

While Focus Minerals's falling revenue is about as heartwarming as a wet blanket, arguably its earnings before interest and tax (EBIT) loss is even less appealing. To be specific the EBIT loss came in at AU$4.2m. 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. However, it doesn't help that it burned through AU$14m 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. We've identified 4 warning signs with Focus Minerals (at least 2 which are a bit concerning) , and understanding them should be part of your investment process.

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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