Does Sumitomo Metal Mining (TSE:5713) Have A Healthy Balance Sheet?

Legendary fund manager Li Lu (who Charlie Munger backed) once said, '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. Importantly, Sumitomo Metal Mining Co., Ltd. (TSE:5713) does carry debt. But is this debt a concern to shareholders?

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Why Does Debt Bring Risk?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. 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, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

What Is Sumitomo Metal Mining's Debt?

You can click the graphic below for the historical numbers, but it shows that as of December 2024 Sumitomo Metal Mining had JP¥617.9b of debt, an increase on JP¥530.3b, over one year. However, because it has a cash reserve of JP¥185.8b, its net debt is less, at about JP¥432.2b.

How Strong Is Sumitomo Metal Mining's Balance Sheet?

The latest balance sheet data shows that Sumitomo Metal Mining had liabilities of JP¥472.6b due within a year, and liabilities of JP¥583.1b falling due after that. Offsetting these obligations, it had cash of JP¥185.8b as well as receivables valued at JP¥178.1b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by JP¥691.8b.

This is a mountain of leverage relative to its market capitalization of JP¥738.8b. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.

Check out our latest analysis for Sumitomo Metal Mining

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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Sumitomo Metal Mining has a debt to EBITDA ratio of 4.8, which signals significant debt, but is still pretty reasonable for most types of business. But its EBIT was about 1k times its interest expense, implying the company isn't really paying a high cost to maintain that level of debt. Even were the low cost to prove unsustainable, that is a good sign. Importantly, Sumitomo Metal Mining's EBIT fell a jaw-dropping 72% in the last twelve months. If that decline continues then paying off debt will be harder than selling foie gras at a vegan convention. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Sumitomo Metal Mining can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

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. Looking at the most recent three years, Sumitomo Metal Mining recorded free cash flow of 27% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

Our View

Mulling over Sumitomo Metal Mining's attempt at (not) growing its EBIT, we're certainly not enthusiastic. But at least it's pretty decent at covering its interest expense with its EBIT; that's encouraging. Overall, it seems to us that Sumitomo Metal Mining's balance sheet is really quite a risk to the business. 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. 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 3 warning signs for Sumitomo Metal Mining (1 doesn't sit too well with us!) that you should be aware of before investing here.

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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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.