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. As with many other companies Metals X Limited (ASX:MLX) makes use of debt. But the more important question is: how much risk is that debt creating?
Why Does Debt Bring Risk?
Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. If things get really bad, the lenders can take control of the business. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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.
See our latest analysis for Metals X
What Is Metals X's Debt?
As you can see below, Metals X had AU$30.0m of debt at December 2020, down from AU$33.7m a year prior. However, it does have AU$15.6m in cash offsetting this, leading to net debt of about AU$14.4m.
How Healthy Is Metals X's Balance Sheet?
We can see from the most recent balance sheet that Metals X had liabilities of AU$82.4m falling due within a year, and liabilities of AU$14.7m due beyond that. Offsetting these obligations, it had cash of AU$15.6m as well as receivables valued at AU$13.3m due within 12 months. So its liabilities total AU$68.1m more than the combination of its cash and short-term receivables.
This deficit isn't so bad because Metals X is worth AU$190.5m, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Metals X can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.
In the last year Metals X wasn't profitable at an EBIT level, but managed to grow its revenue by 3.2%, to AU$155m. We usually like to see faster growth from unprofitable companies, but each to their own.
Caveat Emptor
Over the last twelve months Metals X produced an earnings before interest and tax (EBIT) loss. Its EBIT loss was a whopping AU$63m. 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$26m of cash over the last year. 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 2 warning signs with Metals X , and understanding them should be part of your investment process.
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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About ASX:MLX
Excellent balance sheet and slightly overvalued.
