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Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. Importantly, Amerigo Resources Ltd. (TSE:ARG) does carry debt. But the more important question is: how much risk is that debt creating?
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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.
How Much Debt Does Amerigo Resources Carry?
As you can see below, Amerigo Resources had US$38.1m of debt at June 2021, down from US$53.6m a year prior. But on the other hand it also has US$48.9m in cash, leading to a US$10.8m net cash position.
How Healthy Is Amerigo Resources' Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Amerigo Resources had liabilities of US$53.6m due within 12 months and liabilities of US$71.9m due beyond that. On the other hand, it had cash of US$48.9m and US$12.6m worth of receivables due within a year. So it has liabilities totalling US$64.0m more than its cash and near-term receivables, combined.
This deficit isn't so bad because Amerigo Resources is worth US$181.3m, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt. While it does have liabilities worth noting, Amerigo Resources also has more cash than debt, so we're pretty confident it can manage its debt safely.
It was also good to see that despite losing money on the EBIT line last year, Amerigo Resources turned things around in the last 12 months, delivering and EBIT of US$55m. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Amerigo Resources's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Amerigo Resources has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Over the last year, Amerigo Resources actually produced more free cash flow than EBIT. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.
While Amerigo Resources does have more liabilities than liquid assets, it also has net cash of US$10.8m. And it impressed us with free cash flow of US$67m, being 123% of its EBIT. So we don't have any problem with Amerigo Resources's use of debt. We'd be motivated to research the stock further if we found out that Amerigo Resources insiders have bought shares recently. If you would too, then you're in luck, since today we're sharing our list of reported insider transactions for free.
At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.
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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