Is Majestic Gold (CVE:MJS) Using Too Much Debt?

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. As with many other companies Majestic Gold Corp. (CVE:MJS) makes use of debt. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

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. 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. 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. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Majestic Gold

What Is Majestic Gold's Net Debt?

The image below, which you can click on for greater detail, shows that at September 2021 Majestic Gold had debt of US$9.25m, up from US$7.36m in one year. But on the other hand it also has US$39.1m in cash, leading to a US$29.8m net cash position.

How Healthy Is Majestic Gold's Balance Sheet?

We can see from the most recent balance sheet that Majestic Gold had liabilities of US$34.6m falling due within a year, and liabilities of US$4.96m due beyond that. Offsetting these obligations, it had cash of US$39.1m as well as receivables valued at US$6.7k due within 12 months. So these liquid assets roughly match the total liabilities.

Having regard to Majestic Gold's size, it seems that its liquid assets are well balanced with its total liabilities. So it's very unlikely that the US$44.6m company is short on cash, but still worth keeping an eye on the balance sheet. Despite its noteworthy liabilities, Majestic Gold boasts net cash, so it's fair to say it does not have a heavy debt load!

Fortunately, Majestic Gold grew its EBIT by 5.5% in the last year, making that debt load look even more manageable. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Majestic Gold'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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Majestic Gold may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. During the last three years, Majestic Gold produced sturdy free cash flow equating to 67% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing up

We could understand if investors are concerned about Majestic Gold's liabilities, but we can be reassured by the fact it has has net cash of US$29.8m. And it impressed us with free cash flow of US$22m, being 67% of its EBIT. So we don't think Majestic Gold's use of debt is risky. 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. For example, we've discovered 1 warning sign for Majestic Gold that you should be aware of before investing here.

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.