Here's Why Venus Metals (ASX:VMC) Can Afford Some Debt

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. As with many other companies Venus Metals Corporation Limited (ASX:VMC) makes use of debt. But should shareholders be worried about its use of debt?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Venus Metals

How Much Debt Does Venus Metals Carry?

You can click the graphic below for the historical numbers, but it shows that as of June 2023 Venus Metals had AU$6.70m of debt, an increase on AU$4.55m, over one year. However, because it has a cash reserve of AU$5.08m, its net debt is less, at about AU$1.62m.

How Healthy Is Venus Metals' Balance Sheet?

According to the balance sheet data, Venus Metals had liabilities of AU$7.16m due within 12 months, but no longer term liabilities. On the other hand, it had cash of AU$5.08m and AU$364.7k worth of receivables due within a year. So its liabilities total AU$1.72m more than the combination of its cash and short-term receivables.

Since publicly traded Venus Metals shares are worth a total of AU$21.8m, 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. There's no doubt that we learn most about debt from the balance sheet. But it is Venus Metals'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 Venus Metals has no significant operating revenue, shareholders probably hope it will develop a valuable new mine before too long.

Caveat Emptor

Importantly, Venus Metals had an earnings before interest and tax (EBIT) loss over the last year. Indeed, it lost a very considerable AU$5.7m at the EBIT level. 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. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. Another cause for caution is that is bled AU$4.0m in negative free cash flow over the last twelve months. So in short it's a really risky stock. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 5 warning signs for Venus Metals you should be aware of, and 3 of them are a bit unpleasant.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.