Does Mineral Commodities (ASX:MRC) Have A Healthy Balance Sheet?

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.' 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 Mineral Commodities Ltd (ASX:MRC) does use debt in its business. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own 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 usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Mineral Commodities

How Much Debt Does Mineral Commodities Carry?

As you can see below, at the end of June 2020, Mineral Commodities had US$3.55m of debt, up from US$1.48m a year ago. Click the image for more detail. However, its balance sheet shows it holds US$7.27m in cash, so it actually has US$3.72m net cash.

How Healthy Is Mineral Commodities's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Mineral Commodities had liabilities of US$38.2m due within 12 months and liabilities of US$6.91m due beyond that. Offsetting these obligations, it had cash of US$7.27m as well as receivables valued at US$20.3m due within 12 months. So its liabilities total US$17.5m more than the combination of its cash and short-term receivables.

Since publicly traded Mineral Commodities shares are worth a total of US$118.0m, it seems unlikely that this level of liabilities would be a major threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. While it does have liabilities worth noting, Mineral Commodities also has more cash than debt, so we're pretty confident it can manage its debt safely.

In fact Mineral Commodities's saving grace is its low debt levels, because its EBIT has tanked 37% in the last twelve months. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Mineral Commodities's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Mineral Commodities may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Looking at the most recent three years, Mineral Commodities recorded free cash flow of 44% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

Summing up

Although Mineral Commodities's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of US$3.72m. So we don't have any problem with Mineral Commodities's use of debt. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. Like risks, for instance. Every company has them, and we've spotted 5 warning signs for Mineral Commodities (of which 2 are potentially serious!) you should know about.

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. 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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