Aura Minerals (TSE:ORA) Takes On Some Risk With Its Use Of Debt

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says '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 Aura Minerals Inc. (TSE:ORA) makes use of debt. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Aura Minerals

How Much Debt Does Aura Minerals Carry?

As you can see below, at the end of September 2022, Aura Minerals had US$207.8m of debt, up from US$157.5m a year ago. Click the image for more detail. However, it does have US$121.9m in cash offsetting this, leading to net debt of about US$85.9m.

A Look At Aura Minerals' Liabilities

Zooming in on the latest balance sheet data, we can see that Aura Minerals had liabilities of US$142.9m due within 12 months and liabilities of US$204.9m due beyond that. On the other hand, it had cash of US$121.9m and US$52.1m worth of receivables due within a year. So it has liabilities totalling US$173.9m more than its cash and near-term receivables, combined.

Aura Minerals has a market capitalization of US$569.4m, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (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).

Aura Minerals has net debt of just 0.62 times EBITDA, indicating that it is certainly not a reckless borrower. And it boasts interest cover of 7.2 times, which is more than adequate. In fact Aura Minerals's saving grace is its low debt levels, because its EBIT has tanked 32% in the last twelve months. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Aura Minerals 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Looking at the most recent three years, Aura Minerals recorded free cash flow of 22% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

Our View

Aura Minerals'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. Taking the abovementioned factors together we do think Aura Minerals's debt poses some risks to the business. So while that leverage does boost returns on equity, we wouldn't really want to see it increase from here. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. For instance, we've identified 4 warning signs for Aura Minerals (1 shouldn't be ignored) 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.

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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.