Mangazeya Mining (CVE:MGZ.H) Use Of Debt Could Be Considered Risky

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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. We note that Mangazeya Mining Ltd. (CVE:MGZ.H) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Mangazeya Mining

What Is Mangazeya Mining's Debt?

You can click the graphic below for the historical numbers, but it shows that as of December 2020 Mangazeya Mining had CA$284.3m of debt, an increase on CA$201.2m, over one year. However, because it has a cash reserve of CA$45.7m, its net debt is less, at about CA$238.5m.

How Healthy Is Mangazeya Mining's Balance Sheet?

We can see from the most recent balance sheet that Mangazeya Mining had liabilities of CA$62.3m falling due within a year, and liabilities of CA$253.4m due beyond that. Offsetting these obligations, it had cash of CA$45.7m as well as receivables valued at CA$33.3m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CA$236.6m.

This deficit casts a shadow over the CA$96.6m company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. After all, Mangazeya Mining would likely require a major re-capitalisation if it had to pay its creditors today.

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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

While Mangazeya Mining's debt to EBITDA ratio (4.2) suggests that it uses some debt, its interest cover is very weak, at 2.5, suggesting high leverage. So shareholders should probably be aware that interest expenses appear to have really impacted the business lately. However, it should be some comfort for shareholders to recall that Mangazeya Mining actually grew its EBIT by a hefty 131%, over the last 12 months. If that earnings trend continues it will make its debt load much more manageable in the future. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Mangazeya Mining's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. During the last two years, Mangazeya Mining burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

To be frank both Mangazeya Mining's conversion of EBIT to free cash flow and its track record of staying on top of its total liabilities make us rather uncomfortable with its debt levels. But on the bright side, its EBIT growth rate is a good sign, and makes us more optimistic. We're quite clear that we consider Mangazeya Mining to be really rather risky, as a result of its balance sheet health. So we're almost as wary of this stock as a hungry kitten is about falling into its owner's fish pond: once bitten, twice shy, as they say. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 4 warning signs for Mangazeya Mining you should be aware of, and 2 of them are concerning.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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