Yahoo Finance Health Check: How Prudently Does Middle Island Resources (ASX:MDI) Use Debt?
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. 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 Middle Island Resources Limited (ASX:MDI) does use debt in its business. But the real question is whether this debt is making the company risky.
What Risk Does Debt Bring?
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 thing to do when considering how much debt a business uses is to look at its cash and debt together.
View our latest analysis for Middle Island Resources
How Much Debt Does Middle Island Resources Carry?
The image below, which you can click on for greater detail, shows that at June 2019 Middle Island Resources had debt of AU$32.1k, up from none in one year. However, its balance sheet shows it holds AU$944.4k in cash, so it actually has AU$912.3k net cash.
How Healthy Is Middle Island Resources's Balance Sheet?
The latest balance sheet data shows that Middle Island Resources had liabilities of AU$192.4k due within a year, and liabilities of AU$1.20m falling due after that. Offsetting this, it had AU$944.4k in cash and AU$56.3k in receivables that were due within 12 months. So its liabilities total AU$395.2k more than the combination of its cash and short-term receivables.
Of course, Middle Island Resources has a market capitalization of AU$8.37m, 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, Middle Island Resources also has more cash than debt, so we're pretty confident it can manage its debt safely. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Middle Island Resources 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.
Given its lack of meaningful operating revenue, investors are probably hoping that Middle Island Resources finds some valuable resources, before it runs out of money.
So How Risky Is Middle Island Resources?
By their very nature companies that are losing money are more risky than those with a long history of profitability. And the fact is that over the last twelve months Middle Island Resources lost money at the earnings before interest and tax (EBIT) line. And over the same period it saw negative free cash outflow of AU$2.4m and booked a AU$2.7m accounting loss. With only AU$912.3k on the balance sheet, it would appear that its going to need to raise capital again soon. Summing up, we're a little skeptical of this one, as it seems fairly risky in the absence of free cashflow. For riskier companies like Middle Island Resources I always like to keep an eye on whether insiders are buying or selling. So click here if you want to find out for yourself.
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.
We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.
If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. 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. Simply Wall St has no position in the stocks mentioned. Thank you for reading.
