Minera Valparaiso (SNSE:MINERA) Has A Pretty Healthy Balance Sheet

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says '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. As with many other companies Minera Valparaiso S.A. (SNSE:MINERA) makes use of debt. But is this debt a concern to shareholders?

When Is Debt A Problem?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Minera Valparaiso

What Is Minera Valparaiso's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of December 2020 Minera Valparaiso had US$1.67b of debt, an increase on US$1.54b, over one year. However, it also had US$1.13b in cash, and so its net debt is US$542.5m.

How Healthy Is Minera Valparaiso's Balance Sheet?

We can see from the most recent balance sheet that Minera Valparaiso had liabilities of US$369.1m falling due within a year, and liabilities of US$2.93b due beyond that. Offsetting these obligations, it had cash of US$1.13b as well as receivables valued at US$225.7m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$1.95b.

This deficit is considerable relative to its market capitalization of US$2.78b, so it does suggest shareholders should keep an eye on Minera Valparaiso's use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.

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

Minera Valparaiso has net debt of just 0.85 times EBITDA, indicating that it is certainly not a reckless borrower. And it boasts interest cover of 7.5 times, which is more than adequate. The good news is that Minera Valparaiso has increased its EBIT by 3.4% over twelve months, which should ease any concerns about debt repayment. There's no doubt that we learn most about debt from the balance sheet. But it is Minera Valparaiso'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 we always check how much of that EBIT is translated into free cash flow. Happily for any shareholders, Minera Valparaiso actually produced more free cash flow than EBIT over the last three years. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Our View

When it comes to the balance sheet, the standout positive for Minera Valparaiso was the fact that it seems able to convert EBIT to free cash flow confidently. However, our other observations weren't so heartening. For example, its level of total liabilities makes us a little nervous about its debt. Considering this range of data points, we think Minera Valparaiso 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. But ultimately, every company can contain risks that exist outside of the balance sheet. For example - Minera Valparaiso has 3 warning signs we think you should be aware of.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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