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The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says '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. Importantly, Shanta Gold Limited (LON:SHG) does carry debt. But the real question is whether this debt is making the company risky.
When Is Debt Dangerous?
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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. 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 step when considering a company's debt levels is to consider its cash and debt together.
What Is Shanta Gold's Debt?
As you can see below, Shanta Gold had US$18.2m of debt at December 2020, down from US$28.0m a year prior. But on the other hand it also has US$41.6m in cash, leading to a US$23.4m net cash position.
How Healthy Is Shanta Gold's Balance Sheet?
The latest balance sheet data shows that Shanta Gold had liabilities of US$43.4m due within a year, and liabilities of US$21.1m falling due after that. Offsetting these obligations, it had cash of US$41.6m as well as receivables valued at US$1.43m due within 12 months. So it has liabilities totalling US$21.4m more than its cash and near-term receivables, combined.
Given Shanta Gold has a market capitalization of US$174.1m, it's hard to believe these liabilities pose much threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. While it does have liabilities worth noting, Shanta Gold also has more cash than debt, so we're pretty confident it can manage its debt safely.
Even more impressive was the fact that Shanta Gold grew its EBIT by 812% over twelve months. If maintained that growth will make the debt even more manageable in the years ahead. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Shanta Gold can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.
Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Shanta Gold 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 most recent three years, Shanta Gold recorded free cash flow worth 66% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.
Although Shanta Gold's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of US$23.4m. And we liked the look of last year's 812% year-on-year EBIT growth. So we don't think Shanta Gold's use of debt is risky. 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 4 warning signs for Shanta Gold you should be aware of.
If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.
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. 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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