Taseko Mines (TSE:TKO) Use Of Debt Could Be Considered Risky

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 might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. Importantly, Taseko Mines Limited (TSE:TKO) does carry debt. But is this debt a concern to shareholders?

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. If things get really bad, the lenders can take control of the business. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Taseko Mines

How Much Debt Does Taseko Mines Carry?

As you can see below, at the end of December 2022, Taseko Mines had CA$566.2m of debt, up from CA$508.6m a year ago. Click the image for more detail. On the flip side, it has CA$123.4m in cash leading to net debt of about CA$442.8m.

A Look At Taseko Mines' Liabilities

We can see from the most recent balance sheet that Taseko Mines had liabilities of CA$112.6m falling due within a year, and liabilities of CA$809.6m due beyond that. Offsetting this, it had CA$123.4m in cash and CA$13.2m in receivables that were due within 12 months. So its liabilities total CA$785.6m more than the combination of its cash and short-term receivables.

Given this deficit is actually higher than the company's market capitalization of CA$715.1m, we think shareholders really should watch Taseko Mines's debt levels, like a parent watching their child ride a bike for the first time. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer extensive dilution.

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).

While Taseko Mines's debt to EBITDA ratio (4.4) suggests that it uses some debt, its interest cover is very weak, at 1.4, suggesting high leverage. So shareholders should probably be aware that interest expenses appear to have really impacted the business lately. Worse, Taseko Mines's EBIT was down 58% 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. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Taseko Mines can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Considering the last three years, Taseko Mines actually recorded a cash outflow, overall. Debt is usually more expensive, and almost always more risky in the hands of a company with negative free cash flow. Shareholders ought to hope for an improvement.

Our View

On the face of it, Taseko Mines's interest cover left us tentative about the stock, and its EBIT growth rate was no more enticing than the one empty restaurant on the busiest night of the year. And furthermore, its level of total liabilities also fails to instill confidence. After considering the datapoints discussed, we think Taseko Mines has too much debt. While some investors love that sort of risky play, it's certainly not our cup of tea. Given our concerns about Taseko Mines's debt levels, it seems only prudent to check if insiders have been ditching the stock.

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.