Here's Why Latrobe Magnesium (ASX:LMG) Can Afford Some 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. We can see that Latrobe Magnesium Limited (ASX:LMG) does use debt in its business. 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. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Latrobe Magnesium

How Much Debt Does Latrobe Magnesium Carry?

As you can see below, at the end of June 2023, Latrobe Magnesium had AU$15.3m of debt, up from AU$5.51m a year ago. Click the image for more detail. However, it does have AU$6.89m in cash offsetting this, leading to net debt of about AU$8.44m.

How Healthy Is Latrobe Magnesium's Balance Sheet?

The latest balance sheet data shows that Latrobe Magnesium had liabilities of AU$16.9m due within a year, and liabilities of AU$19.3m falling due after that. Offsetting these obligations, it had cash of AU$6.89m as well as receivables valued at AU$13.8m due within 12 months. So it has liabilities totalling AU$15.5m more than its cash and near-term receivables, combined.

Of course, Latrobe Magnesium has a market capitalization of AU$83.2m, so these liabilities are probably manageable. 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 Latrobe Magnesium 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 Latrobe Magnesium has no significant operating revenue, shareholders probably hope it will develop a valuable new mine before too long.

Caveat Emptor

Over the last twelve months Latrobe Magnesium produced an earnings before interest and tax (EBIT) loss. To be specific the EBIT loss came in at AU$2.5m. 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. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. Another cause for caution is that is bled AU$22m in negative free cash flow over the last twelve months. So in short it's a really risky stock. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. We've identified 5 warning signs with Latrobe Magnesium (at least 3 which make us uncomfortable) , and understanding them should be part of your investment process.

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. 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.