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Is Kinross Gold (TSE:K) A Risky Investment?

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.’ So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We note that Kinross Gold Corporation (TSE:K) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

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. Ultimately, if the company can’t fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Having said that, the most common situation is where a company manages its debt reasonably well – and to its own advantage. When we think about a company’s use of debt, we first look at cash and debt together.

Our analysis indicates that K is potentially overvalued!

What Is Kinross Gold’s Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2022 Kinross Gold had US$2.51b of debt, an increase on US$1.43b, over one year. However, because it has a cash reserve of US$496.5m, its net debt is less, at about US$2.02b.

debt-equity-history-analysis
TSX:K Debt to Equity History November 25th 2022

How Strong Is Kinross Gold’s Balance Sheet?

The latest balance sheet data shows that Kinross Gold had liabilities of US$643.1m due within a year, and liabilities of US$3.66b falling due after that. On the other hand, it had cash of US$496.5m and US$214.7m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$3.60b.

This deficit is considerable relative to its market capitalization of US$5.26b, so it does suggest shareholders should keep an eye on Kinross Gold’s use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.

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). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Kinross Gold’s net debt of 1.5 times EBITDA suggests graceful use of debt. And the fact that its trailing twelve months of EBIT was 9.2 times its interest expenses harmonizes with that theme. It is just as well that Kinross Gold’s load is not too heavy, because its EBIT was down 60% over the last year. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Kinross Gold 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. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. In the last three years, Kinross Gold’s free cash flow amounted to 44% of its EBIT, less than we’d expect. That weak cash conversion makes it more difficult to handle indebtedness.

Our View

We’d go so far as to say Kinross Gold’s EBIT growth rate was disappointing. But at least it’s pretty decent at covering its interest expense with its EBIT; that’s encouraging. Once we consider all the factors above, together, it seems to us that Kinross Gold’s debt is making it a bit risky. That’s not necessarily a bad thing, but we’d generally feel more comfortable with less leverage. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet – far from it. Case in point: We’ve spotted 2 warning signs for Kinross 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.

Valuation is complex, but we’re helping make it simple.

Find out whether Kinross Gold is potentially over or undervalued by checking out our comprehensive analysis, which includes fair value estimates, risks and warnings, dividends, insider transactions and financial health.

View the Free Analysis

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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