Is Hudbay Minerals (TSE:HBM) Using Too Much Debt?

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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 Hudbay Minerals Inc. (TSE:HBM) makes use of debt. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Hudbay Minerals

What Is Hudbay Minerals's Debt?

You can click the graphic below for the historical numbers, but it shows that as of June 2023 Hudbay Minerals had US$1.37b of debt, an increase on US$1.18b, over one year. On the flip side, it has US$179.7m in cash leading to net debt of about US$1.19b.

A Look At Hudbay Minerals' Liabilities

The latest balance sheet data shows that Hudbay Minerals had liabilities of US$601.4m due within a year, and liabilities of US$2.53b falling due after that. Offsetting these obligations, it had cash of US$179.7m as well as receivables valued at US$101.9m due within 12 months. So its liabilities total US$2.85b more than the combination of its cash and short-term receivables.

This deficit casts a shadow over the US$1.63b company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. At the end of the day, Hudbay Minerals would probably need a major re-capitalization if its creditors were to demand repayment.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

While Hudbay Minerals's debt to EBITDA ratio (2.7) suggests that it uses some debt, its interest cover is very weak, at 1.5, suggesting high leverage. It seems that the business incurs large depreciation and amortisation charges, so maybe its debt load is heavier than it would first appear, since EBITDA is arguably a generous measure of earnings. It seems clear that the cost of borrowing money is negatively impacting returns for shareholders, of late. Worse, Hudbay Minerals's EBIT was down 47% over the last year. If earnings continue to follow that trajectory, paying off that debt load will be harder than convincing us to run a marathon in the rain. 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 Hudbay Minerals'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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we always check how much of that EBIT is translated into free cash flow. In the last three years, Hudbay Minerals's free cash flow amounted to 29% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Our View

To be frank both Hudbay Minerals's EBIT growth rate and its track record of staying on top of its total liabilities make us rather uncomfortable with its debt levels. But at least its net debt to EBITDA is not so bad. After considering the datapoints discussed, we think Hudbay Minerals has too much debt. While some investors love that sort of risky play, it's certainly not our cup of tea. 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. For example, we've discovered 1 warning sign for Hudbay Minerals that you should be aware of before investing here.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.