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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. We can see that Endeavour Silver Corp. (TSE:EDR) does use debt in its business. But should shareholders be worried about its use of debt?
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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. The first step when considering a company's debt levels is to consider its cash and debt together.
How Much Debt Does Endeavour Silver Carry?
You can click the graphic below for the historical numbers, but it shows that as of March 2022 Endeavour Silver had US$12.3m of debt, an increase on US$8.70m, over one year. But it also has US$164.9m in cash to offset that, meaning it has US$152.6m net cash.
A Look At Endeavour Silver's Liabilities
The latest balance sheet data shows that Endeavour Silver had liabilities of US$40.7m due within a year, and liabilities of US$22.6m falling due after that. Offsetting these obligations, it had cash of US$164.9m as well as receivables valued at US$13.6m due within 12 months. So it actually has US$115.2m more liquid assets than total liabilities.
It's good to see that Endeavour Silver has plenty of liquidity on its balance sheet, suggesting conservative management of liabilities. Due to its strong net asset position, it is not likely to face issues with its lenders. Succinctly put, Endeavour Silver boasts net cash, so it's fair to say it does not have a heavy debt load!
Even more impressive was the fact that Endeavour Silver grew its EBIT by 158% 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 Endeavour Silver 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, a company can only pay off debt with cold hard cash, not accounting profits. While Endeavour Silver 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 two years, Endeavour Silver recorded negative free cash flow, in total. Debt is far more risky for companies with unreliable free cash flow, so shareholders should be hoping that the past expenditure will produce free cash flow in the future.
While it is always sensible to investigate a company's debt, in this case Endeavour Silver has US$152.6m in net cash and a decent-looking balance sheet. And it impressed us with its EBIT growth of 158% over the last year. So we don't think Endeavour Silver's use of debt is risky. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. We've identified 5 warning signs with Endeavour Silver , and understanding them should be part of your investment process.
Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.
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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.