Stock Analysis

Here's Why Lundin Gold (TSE:LUG) Can Manage Its Debt Responsibly

  •  Updated
TSX:LUG
Source: Shutterstock

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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 Lundin Gold Inc. (TSE:LUG) does use debt in its business. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Lundin Gold

How Much Debt Does Lundin Gold Carry?

You can click the graphic below for the historical numbers, but it shows that Lundin Gold had US$645.7m of debt in June 2022, down from US$772.4m, one year before. On the flip side, it has US$301.0m in cash leading to net debt of about US$344.7m.

debt-equity-history-analysis
TSX:LUG Debt to Equity History September 27th 2022

How Strong Is Lundin Gold's Balance Sheet?

We can see from the most recent balance sheet that Lundin Gold had liabilities of US$315.4m falling due within a year, and liabilities of US$438.4m due beyond that. Offsetting this, it had US$301.0m in cash and US$143.9m in receivables that were due within 12 months. So it has liabilities totalling US$308.9m more than its cash and near-term receivables, combined.

While this might seem like a lot, it is not so bad since Lundin Gold has a market capitalization of US$1.52b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But it's clear that we should definitely closely examine whether it can manage its debt without dilution.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Lundin Gold has net debt of just 0.76 times EBITDA, indicating that it is certainly not a reckless borrower. And this view is supported by the solid interest coverage, with EBIT coming in at 9.6 times the interest expense over the last year. Fortunately, Lundin Gold grew its EBIT by 5.7% in the last year, making that debt load look even more manageable. 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 Lundin Gold can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So it's worth checking how much of that EBIT is backed by free cash flow. During the last two years, Lundin Gold generated free cash flow amounting to a very robust 93% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.

Our View

Lundin Gold's conversion of EBIT to free cash flow suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. And the good news does not stop there, as its interest cover also supports that impression! Zooming out, Lundin Gold seems to use debt quite reasonably; and that gets the nod from us. After all, sensible leverage can boost returns on equity. 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 instance, we've identified 2 warning signs for Lundin Gold (1 is significant) you should be aware of.

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.

Valuation is complex, but we're helping make it simple.

Find out whether Lundin Gold is potentially over or undervalued by checking out our comprehensive analysis, which includes fair value estimates, risks and warnings, dividends, insider transactions and financial health.

View the Free Analysis

About TSX:LUG

Lundin Gold

Lundin Gold Inc. operates as a mining company in Canada.

The Snowflake is a visual investment summary with the score of each axis being calculated by 6 checks in 5 areas.

Analysis AreaScore (0-6)
Valuation1
Future Growth0
Past Performance2
Financial Health6
Dividends3

Read more about these checks in the individual report sections or in our analysis model.

Flawless balance sheet second-rate dividend payer.