Yahoo Finance We Think Largo Resources (TSE:LGO) Can Manage Its Debt With Ease
Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We note that Largo Resources Ltd. (TSE:LGO) 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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
Check out our latest analysis for Largo Resources
What Is Largo Resources's Debt?
The image below, which you can click on for greater detail, shows that Largo Resources had debt of US$15.0m at the end of June 2021, a reduction from US$24.8m over a year. But on the other hand it also has US$80.7m in cash, leading to a US$65.7m net cash position.
A Look At Largo Resources' Liabilities
According to the last reported balance sheet, Largo Resources had liabilities of US$39.8m due within 12 months, and liabilities of US$8.26m due beyond 12 months. Offsetting these obligations, it had cash of US$80.7m as well as receivables valued at US$25.7m due within 12 months. So it can boast US$58.3m more liquid assets than total liabilities.
This surplus suggests that Largo Resources has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, Largo Resources boasts net cash, so it's fair to say it does not have a heavy debt load!
Even more impressive was the fact that Largo Resources grew its EBIT by 1,049% over twelve months. If maintained that growth will make the debt even more manageable in the years ahead. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Largo Resources 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 Largo 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 three years, Largo Resources recorded free cash flow worth a fulsome 94% of its EBIT, which is stronger than we'd usually expect. That puts it in a very strong position to pay down debt.
Summing up
While we empathize with investors who find debt concerning, you should keep in mind that Largo Resources has net cash of US$65.7m, as well as more liquid assets than liabilities. And it impressed us with free cash flow of US$2.2m, being 94% of its EBIT. So is Largo Resources's debt a risk? It doesn't seem so to us. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. For example - Largo Resources has 2 warning signs we think you should be aware of.
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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