These 4 Measures Indicate That Atico Mining (CVE:ATY) Is Using Debt Reasonably Well

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 Atico Mining Corporation (CVE:ATY) does use debt in its business. 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. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. 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 Atico Mining

How Much Debt Does Atico Mining Carry?

The image below, which you can click on for greater detail, shows that at March 2021 Atico Mining had debt of US$9.61m, up from US$2.76m in one year. However, it does have US$9.20m in cash offsetting this, leading to net debt of about US$413.4k.

How Healthy Is Atico Mining's Balance Sheet?

According to the last reported balance sheet, Atico Mining had liabilities of US$20.1m due within 12 months, and liabilities of US$24.4m due beyond 12 months. Offsetting this, it had US$9.20m in cash and US$21.5m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$13.7m.

Atico Mining has a market capitalization of US$47.7m, 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. Carrying virtually no net debt, Atico 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).

Atico Mining has very little debt (net of cash), and boasts a debt to EBITDA ratio of 0.014 and EBIT of 27.7 times the interest expense. So relative to past earnings, the debt load seems trivial. Even more impressive was the fact that Atico Mining grew its EBIT by 246% over twelve months. That boost will make it even easier to pay down debt going forward. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Atico Mining's ability to maintain a healthy balance sheet going forward. 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 the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. In the last three years, Atico Mining's free cash flow amounted to 42% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Our View

The good news is that Atico Mining's demonstrated ability to cover its interest expense with its EBIT delights us like a fluffy puppy does a toddler. And the good news does not stop there, as its EBIT growth rate also supports that impression! When we consider the range of factors above, it looks like Atico Mining is pretty sensible with its use of debt. That means they are taking on a bit more risk, in the hope of boosting shareholder returns. The balance sheet is clearly the area to focus on when you are analysing debt. 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 Atico 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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