Is Latrobe Magnesium (ASX:LMG) A Risky Investment?

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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 can see that Latrobe Magnesium Limited (ASX:LMG) does use debt in its business. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Latrobe Magnesium

What Is Latrobe Magnesium's Net Debt?

The image below, which you can click on for greater detail, shows that at December 2020 Latrobe Magnesium had debt of AU$4.79m, up from AU$2.67m in one year. Net debt is about the same, since the it doesn't have much cash.

A Look At Latrobe Magnesium's Liabilities

The latest balance sheet data shows that Latrobe Magnesium had liabilities of AU$7.81m due within a year, and liabilities of AU$8.10m falling due after that. On the other hand, it had cash of AU$5.9k and AU$11.0m worth of receivables due within a year. So its liabilities total AU$4.89m more than the combination of its cash and short-term receivables.

Since publicly traded Latrobe Magnesium shares are worth a total of AU$25.0m, 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. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Latrobe Magnesium 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 Latrobe Magnesium finds some valuable resources, before it runs out of money.

Caveat Emptor

Not only did Latrobe Magnesium's revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). Indeed, it lost AU$1.4m at the EBIT level. Considering that alongside the liabilities mentioned above does not give us much confidence that company should be using so much debt. So we think its balance sheet is a little strained, though not beyond repair. Another cause for caution is that is bled AU$1.1m 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. However, not all investment risk resides within the balance sheet - far from it. For example Latrobe Magnesium has 4 warning signs (and 3 which are concerning) we think you should know about.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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This article by Simply Wall St is general in nature. 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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