Is Lundin Mining (TSE:LUN) A Risky Investment?

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. We can see that Lundin Mining Corporation (TSE:LUN) does use debt in its business. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

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. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. 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 Mining

What Is Lundin Mining's Debt?

You can click the graphic below for the historical numbers, but it shows that as of March 2023 Lundin Mining had US$189.2m of debt, an increase on US$4.39m, over one year. However, because it has a cash reserve of US$184.2m, its net debt is less, at about US$4.98m.

A Look At Lundin Mining's Liabilities

According to the last reported balance sheet, Lundin Mining had liabilities of US$982.7m due within 12 months, and liabilities of US$1.80b due beyond 12 months. Offsetting these obligations, it had cash of US$184.2m as well as receivables valued at US$580.9m due within 12 months. So it has liabilities totalling US$2.02b more than its cash and near-term receivables, combined.

This deficit isn't so bad because Lundin Mining is worth US$5.89b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. Carrying virtually no net debt, Lundin Mining has a very light debt load indeed.

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). 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).

With net debt at just 0.0072 times EBITDA, it seems Lundin Mining only uses a little bit of leverage. Although with EBIT only covering interest expenses 6.0 times over, the company is truly paying for borrowing. Importantly, Lundin Mining's EBIT fell a jaw-dropping 82% in the last twelve months. If that decline continues then paying off debt will be harder than selling foie gras at a vegan convention. 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 Mining 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 we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Looking at the most recent three years, Lundin Mining recorded free cash flow of 47% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Our View

Lundin Mining's EBIT growth rate was a real negative on this analysis, although the other factors we considered cast it in a significantly better light. For example its net debt to EBITDA was refreshing. We think that Lundin Mining's debt does make it a bit risky, after considering the aforementioned data points together. That's not necessarily a bad thing, since leverage can boost returns on equity, but it is something to be aware of. 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. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for Lundin Mining 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. 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.