These 4 Measures Indicate That Medusa Mining (ASX:MML) Is Using Debt Safely

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.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. Importantly, Medusa Mining Limited (ASX:MML) does carry debt. But is this debt a concern to shareholders?

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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Medusa Mining

What Is Medusa Mining's Debt?

As you can see below, Medusa Mining had US$2.54m of debt at December 2020, down from US$5.72m a year prior. But on the other hand it also has US$78.9m in cash, leading to a US$76.4m net cash position.

How Healthy Is Medusa Mining's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Medusa Mining had liabilities of US$21.6m due within 12 months and liabilities of US$7.28m due beyond that. On the other hand, it had cash of US$78.9m and US$11.7m worth of receivables due within a year. So it can boast US$61.8m more liquid assets than total liabilities.

This excess liquidity is a great indication that Medusa Mining's balance sheet is almost as strong as Fort Knox. Having regard to this fact, we think its balance sheet is as strong as an ox. Simply put, the fact that Medusa Mining has more cash than debt is arguably a good indication that it can manage its debt safely.

In addition to that, we're happy to report that Medusa Mining has boosted its EBIT by 44%, thus reducing the spectre of future debt repayments. 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 Medusa Mining 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.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Medusa Mining has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. During the last two years, Medusa Mining produced sturdy free cash flow equating to 77% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Medusa Mining has net cash of US$76.4m, as well as more liquid assets than liabilities. And we liked the look of last year's 44% year-on-year EBIT growth. The bottom line is that Medusa Mining's use of debt is absolutely fine. We'd be very excited to see if Medusa Mining insiders have been snapping up shares. If you are too, then click on this link right now to take a (free) peek at our list of reported insider transactions.

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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