Is Alphamin Resources (CVE:AFM) Using Too Much Debt?

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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 Alphamin Resources Corp. (CVE:AFM) makes use of debt. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Alphamin Resources

What Is Alphamin Resources's Debt?

You can click the graphic below for the historical numbers, but it shows that Alphamin Resources had US$54.8m of debt in March 2021, down from US$94.8m, one year before. However, it does have US$11.3m in cash offsetting this, leading to net debt of about US$43.4m.

A Look At Alphamin Resources' Liabilities

Zooming in on the latest balance sheet data, we can see that Alphamin Resources had liabilities of US$62.9m due within 12 months and liabilities of US$43.9m due beyond that. Offsetting these obligations, it had cash of US$11.3m as well as receivables valued at US$33.0m due within 12 months. So its liabilities total US$62.4m more than the combination of its cash and short-term receivables.

Since publicly traded Alphamin Resources shares are worth a total of US$712.9m, it seems unlikely that this level of liabilities would be a major threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward.

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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

While Alphamin Resources's low debt to EBITDA ratio of 0.59 suggests only modest use of debt, the fact that EBIT only covered the interest expense by 5.4 times last year does give us pause. So we'd recommend keeping a close eye on the impact financing costs are having on the business. Notably, Alphamin Resources made a loss at the EBIT level, last year, but improved that to positive EBIT of US$55m in the last twelve months. 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 Alphamin Resources 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, a company can only pay off debt with cold hard cash, not accounting profits. So it is important to check how much of its earnings before interest and tax (EBIT) converts to actual free cash flow. In the last year, Alphamin Resources's free cash flow amounted to 37% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Our View

On our analysis Alphamin Resources's net debt to EBITDA should signal that it won't have too much trouble with its debt. However, our other observations weren't so heartening. For instance it seems like it has to struggle a bit to convert EBIT to free cash flow. Considering this range of data points, we think Alphamin Resources is in a good position to manage its debt levels. Having said that, the load is sufficiently heavy that we would recommend any shareholders keep a close eye on it. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 2 warning signs for Alphamin Resources you should be aware of.

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. 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.
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