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. We note that Hecla Mining Company (NYSE:HL) does have debt on its balance sheet. But is this debt a concern to shareholders?
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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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 step when considering a company’s debt levels is to consider its cash and debt together.
How Much Debt Does Hecla Mining Carry?
The chart below, which you can click on for greater detail, shows that Hecla Mining had US$508.1m in debt in December 2021; about the same as the year before. However, because it has a cash reserve of US$210.0m, its net debt is less, at about US$298.1m.
A Look At Hecla Mining’s Liabilities
Zooming in on the latest balance sheet data, we can see that Hecla Mining had liabilities of US$160.4m due within 12 months and liabilities of US$807.6m due beyond that. On the other hand, it had cash of US$210.0m and US$44.6m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$713.4m.
Given Hecla Mining has a market capitalization of US$3.68b, it’s hard to believe these liabilities pose much threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward.
In order to size up a company’s debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.
While Hecla Mining’s low debt to EBITDA ratio of 1.0 suggests only modest use of debt, the fact that EBIT only covered the interest expense by 2.9 times last year does give us pause. But the interest payments are certainly sufficient to have us thinking about how affordable its debt is. Also relevant is that Hecla Mining has grown its EBIT by a very respectable 29% in the last year, thus enhancing its ability to pay down debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Hecla Mining’s ability to maintain a healthy balance sheet going forward.
Finally, a business needs free cash flow to pay off debt; accounting profits just don’t cut it. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. During the last two years, Hecla Mining generated free cash flow amounting to a very robust 94% of its EBIT, more than we’d expect. That puts it in a very strong position to pay down debt.
Hecla Mining’s conversion of EBIT to free cash flow suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14’s goalkeeper. But the stark truth is that we are concerned by its interest cover. Looking at the bigger picture, we think Hecla Mining’s use of debt seems quite reasonable and we’re not concerned about it. After all, sensible leverage can boost returns on equity. There’s no doubt that we learn most about debt from the balance sheet.