OZ Minerals (ASX:OZL) Seems To Use Debt Quite Sensibly

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.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. As with many other companies OZ Minerals Limited (ASX:OZL) makes use of debt. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

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. If things get really bad, the lenders can take control of the business. 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, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for OZ Minerals

What Is OZ Minerals's Debt?

You can click the graphic below for the historical numbers, but it shows that as of December 2020 OZ Minerals had AU$100.0m of debt, an increase on none, over one year. However, its balance sheet shows it holds AU$131.7m in cash, so it actually has AU$31.7m net cash.

A Look At OZ Minerals' Liabilities

According to the last reported balance sheet, OZ Minerals had liabilities of AU$446.9m due within 12 months, and liabilities of AU$1.10b due beyond 12 months. On the other hand, it had cash of AU$131.7m and AU$173.8m worth of receivables due within a year. So its liabilities total AU$1.24b more than the combination of its cash and short-term receivables.

Given OZ Minerals has a market capitalization of AU$8.75b, it's hard to believe these liabilities pose much 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, OZ Minerals also has more cash than debt, so we're pretty confident it can manage its debt safely.

In addition to that, we're happy to report that OZ Minerals has boosted its EBIT by 48%, thus reducing the spectre of future debt repayments. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if OZ Minerals 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.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. OZ Minerals 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. During the last three years, OZ Minerals burned a lot of cash. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Summing up

Although OZ Minerals's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of AU$31.7m. And it impressed us with its EBIT growth of 48% over the last year. So we are not troubled with OZ Minerals's debt use. 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 - OZ Minerals has 1 warning sign we think you should be aware of.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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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