Is Latrobe Magnesium (ASX:LMG) Using Debt In A Risky Way?

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 Latrobe Magnesium Limited (ASX:LMG) does have debt on its balance sheet. But is this debt a concern to shareholders?

When Is Debt Dangerous?

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. 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.

See our latest analysis for Latrobe Magnesium

What Is Latrobe Magnesium's Net Debt?

As you can see below, at the end of June 2022, Latrobe Magnesium had AU$5.51m of debt, up from none a year ago. Click the image for more detail. However, it does have AU$15.2m in cash offsetting this, leading to net cash of AU$9.74m.

How Healthy Is Latrobe Magnesium's Balance Sheet?

The latest balance sheet data shows that Latrobe Magnesium had liabilities of AU$3.62m due within a year, and liabilities of AU$11.1m falling due after that. Offsetting these obligations, it had cash of AU$15.2m as well as receivables valued at AU$3.40m due within 12 months. So it actually has AU$3.97m more liquid assets than total liabilities.

This short term liquidity is a sign that Latrobe Magnesium could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that Latrobe Magnesium has more cash than debt is arguably a good indication that it can manage its debt safely. When analysing debt levels, the balance sheet is the obvious place to start. But it is Latrobe Magnesium's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

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

So How Risky Is Latrobe Magnesium?

Statistically speaking companies that lose money are riskier than those that make money. And we do note that Latrobe Magnesium had an earnings before interest and tax (EBIT) loss, over the last year. Indeed, in that time it burnt through AU$7.1m of cash and made a loss of AU$3.2m. With only AU$9.74m on the balance sheet, it would appear that its going to need to raise capital again soon. Overall, its balance sheet doesn't seem overly risky, at the moment, but we're always cautious until we see the positive free cash flow. 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 example, we've discovered 4 warning signs for Latrobe Magnesium (2 can't be ignored!) that you should be aware of before investing here.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.