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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 should shareholders be worried about its use of debt?
When Is Debt A Problem?
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. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.
How Much Debt Does Majestic Gold Carry?
As you can see below, Majestic Gold had US$9.29m of debt at June 2021, down from US$9.92m a year prior. But it also has US$35.3m in cash to offset that, meaning it has US$26.0m net cash.
A Look At Majestic Gold's Liabilities
According to the last reported balance sheet, Majestic Gold had liabilities of US$33.5m due within 12 months, and liabilities of US$4.87m due beyond 12 months. On the other hand, it had cash of US$35.3m and US$12.1k worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$3.05m.
Of course, Majestic Gold has a market capitalization of US$49.6m, so these liabilities are probably manageable. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. While it does have liabilities worth noting, Majestic Gold also has more cash than debt, so we're pretty confident it can manage its debt safely.
On top of that, Majestic Gold grew its EBIT by 64% over the last twelve months, and that growth will make it easier to handle its debt. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Majestic Gold 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. 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. In the last three years, Majestic Gold's free cash flow amounted to 43% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.
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$26.0m. And it impressed us with its EBIT growth of 64% over the last year. So is Majestic Gold's debt a risk? It doesn't seem so to us. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 1 warning sign for Majestic Gold 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.
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.
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