Berkshire Hathaway’s Charlie Munger-backed external fund manager Li Lu is quick to say “The biggest risk in investing is not price volatility, but whether you will suffer a permanent loss of capital”. When we think about how risky a business is, we always like to look at its use of debt because debt overload can lead to bankruptcy. We can see that Or Yamana inc. (TSE: YRI) uses debt in its business. But the real question is whether this debt makes the business risky.
When is debt dangerous?
Debt is a tool to help businesses grow, but if a business is unable to repay its lenders, then it exists at their mercy. If things really go wrong, lenders can take over the business. However, a more common (but still costly) situation is where a company has to dilute its shareholders at a cheap share price just to get its debt under control. Of course, many companies use debt to finance their growth without negative consequences. When we look at debt levels, we first consider both liquidity and debt levels.
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What is Yamana Gold’s debt?
As you can see below, Yamana Gold had $ 1.01 billion in debt in March 2021, up from $ 1.24 billion the year before. However, given that it has a cash reserve of US $ 698.4 million, its net debt is less, at around US $ 310.5 million.
Is Yamana Gold’s track record healthy?
According to the latest published balance sheet, Yamana Gold had liabilities of US $ 614.8 million due within 12 months and liabilities of US $ 2.63 billion due beyond 12 months. On the other hand, he had $ 698.4 million in cash and $ 4.60 million in receivables within a year. It therefore has liabilities totaling $ 2.54 billion more than its cash and short-term receivables combined.
This deficit is not that big as Yamana Gold is worth US $ 4.27 billion, and could therefore probably raise enough capital to consolidate its balance sheet, should the need arise. However, it is always worth taking a close look at your ability to repay debts.
In order to measure a company’s debt relative to its profits, we calculate its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and its profit before interest and taxes (EBIT) divided by its interest. debtors (its interest coverage). In this way, we consider both the absolute amount of debt, as well as the interest rates paid on it.
Yamana Gold has a low net debt to EBITDA ratio of just 0.37. And its EBIT easily covers its interest costs, being 11.5 times higher. We could therefore say that he is no more threatened by his debt than an elephant is by a mouse. Best of all, Yamana Gold increased its EBIT by 216% last year, which is an impressive improvement. This boost will make it even easier to pay down debt in the future. When analyzing debt levels, the balance sheet is the obvious starting point. But ultimately, the company’s future profitability will decide whether Yamana Gold can strengthen its balance sheet over time. So, if you want to see what the professionals think, you might find this free analyst earnings forecast report interesting.
Finally, while the IRS may love accounting profits, lenders only accept hard cash. We therefore always check how much of this EBIT is converted into free cash flow. Over the past three years, Yamana Gold’s free cash flow has been 50% of its EBIT, less than we expected. This low cash conversion makes debt management more difficult.
Our point of view
Yamana Gold’s growth rate of EBIT suggests he can manage his debt as easily as Cristiano Ronaldo could score a goal against an Under-14 goalkeeper. But, on a darker note, we’re a little concerned with its total liability level. Considering all of this data, it seems to us that Yamana Gold is taking a pretty sane approach to debt. While this carries some risk, it can also improve returns for shareholders. There is no doubt that we learn the most about debt from the balance sheet. However, not all investment risks lie on the balance sheet – far from it. We have identified 3 warning signs with Yamana Gold (at least 1 that shouldn’t be ignored), and understanding them should be part of your investment process.
At the end of the day, sometimes it’s easier to focus on businesses that don’t even need to go into debt. Readers can access a list of growth stocks with zero net debt 100% free, at present.
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