Is Santacruz Silver Mining (CVE:SCZ) 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. Importantly, Santacruz Silver Mining Ltd. (CVE:SCZ) does carry debt. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Santacruz Silver Mining

What Is Santacruz Silver Mining's Net Debt?

You can click the graphic below for the historical numbers, but it shows that Santacruz Silver Mining had US$17.6m of debt in March 2024, down from US$21.1m, one year before. However, because it has a cash reserve of US$4.04m, its net debt is less, at about US$13.6m.

How Strong Is Santacruz Silver Mining's Balance Sheet?

The latest balance sheet data shows that Santacruz Silver Mining had liabilities of US$102.8m due within a year, and liabilities of US$101.1m falling due after that. Offsetting this, it had US$4.04m in cash and US$72.9m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$127.0m.

The deficiency here weighs heavily on the US$82.8m company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we definitely think shareholders need to watch this one closely. After all, Santacruz Silver Mining would likely require a major re-capitalisation if it had to pay its creditors today.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Given net debt is only 0.60 times EBITDA, it is initially surprising to see that Santacruz Silver Mining's EBIT has low interest coverage of 1.0 times. So one way or the other, it's clear the debt levels are not trivial. Pleasingly, Santacruz Silver Mining is growing its EBIT faster than former Australian PM Bob Hawke downs a yard glass, boasting a 306% gain in the last twelve months. There's no doubt that we learn most about debt from the balance sheet. But it is Santacruz Silver 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.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the last two years, Santacruz Silver Mining actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Our View

While Santacruz Silver Mining's interest cover has us nervous. To wit both its conversion of EBIT to free cash flow and EBIT growth rate were encouraging signs. We think that Santacruz Silver Mining's debt does make it a bit risky, after considering the aforementioned data points together. That's not necessarily a bad thing, since leverage can boost returns on equity, but it is something to be aware of. 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. Be aware that Santacruz Silver Mining is showing 3 warning signs in our investment analysis , you should know about...

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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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.