Stock Analysis

Dragon Mining (HKG:1712) Has A Pretty Healthy Balance Sheet

SEHK:1712
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Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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 Dragon Mining Limited (HKG:1712) makes use of debt. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Dragon Mining

How Much Debt Does Dragon Mining Carry?

You can click the graphic below for the historical numbers, but it shows that Dragon Mining had AU$3.00m of debt in June 2020, down from AU$6.30m, one year before. However, it does have AU$11.7m in cash offsetting this, leading to net cash of AU$8.75m.

debt-equity-history-analysis
SEHK:1712 Debt to Equity History December 6th 2020

How Healthy Is Dragon Mining's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Dragon Mining had liabilities of AU$8.18m due within 12 months and liabilities of AU$21.5m due beyond that. Offsetting these obligations, it had cash of AU$11.7m as well as receivables valued at AU$4.36m due within 12 months. So it has liabilities totalling AU$13.5m more than its cash and near-term receivables, combined.

This deficit isn't so bad because Dragon Mining is worth AU$47.7m, and thus could probably raise enough capital to shore up 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. While it does have liabilities worth noting, Dragon Mining also has more cash than debt, so we're pretty confident it can manage its debt safely.

Although Dragon Mining made a loss at the EBIT level, last year, it was also good to see that it generated AU$9.5m in EBIT over the last twelve months. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Dragon Mining will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Dragon Mining has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Over the most recent year, Dragon Mining recorded free cash flow worth 55% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Summing up

While Dragon Mining does have more liabilities than liquid assets, it also has net cash of AU$8.75m. So we don't have any problem with Dragon Mining's use of debt. 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. Case in point: We've spotted 1 warning sign for Dragon Mining you should be aware of.

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. 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.
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