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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We can see that Perseus Mining Limited (ASX:PRU) does use debt in its business. But the real question is whether this debt is making the company risky.
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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
How Much Debt Does Perseus Mining Carry?
The image below, which you can click on for greater detail, shows that Perseus Mining had debt of AU$133.2m at the end of June 2021, a reduction from AU$217.7m over a year. However, its balance sheet shows it holds AU$181.5m in cash, so it actually has AU$48.3m net cash.
How Healthy Is Perseus Mining's Balance Sheet?
According to the last reported balance sheet, Perseus Mining had liabilities of AU$124.6m due within 12 months, and liabilities of AU$225.9m due beyond 12 months. On the other hand, it had cash of AU$181.5m and AU$18.6m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by AU$150.3m.
Since publicly traded Perseus Mining shares are worth a total of AU$2.11b, it seems unlikely that this level of liabilities would be a major threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. Despite its noteworthy liabilities, Perseus Mining boasts net cash, so it's fair to say it does not have a heavy debt load!
On top of that, Perseus Mining grew its EBIT by 52% over the last twelve months, and that growth will make it easier to handle its debt. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Perseus 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.
Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Perseus Mining 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. Over the last two years, Perseus Mining recorded negative free cash flow, in total. Debt is far more risky for companies with unreliable free cash flow, so shareholders should be hoping that the past expenditure will produce free cash flow in the future.
We could understand if investors are concerned about Perseus Mining's liabilities, but we can be reassured by the fact it has has net cash of AU$48.3m. And we liked the look of last year's 52% year-on-year EBIT growth. So we don't have any problem with Perseus Mining's use of debt. Over time, share prices tend to follow earnings per share, so if you're interested in Perseus Mining, you may well want to click here to check an interactive graph of its earnings per share history.
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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