Here's Why Nagambie Resources (ASX:NAG) Can Afford Some Debt

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.' 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 can see that Nagambie Resources Limited (ASX:NAG) does use debt in its business. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

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 usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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.

See our latest analysis for Nagambie Resources

What Is Nagambie Resources's Net Debt?

As you can see below, at the end of December 2022, Nagambie Resources had AU$7.10m of debt, up from AU$5.68m a year ago. Click the image for more detail. However, because it has a cash reserve of AU$1.43m, its net debt is less, at about AU$5.66m.

A Look At Nagambie Resources' Liabilities

According to the last reported balance sheet, Nagambie Resources had liabilities of AU$1.25m due within 12 months, and liabilities of AU$7.13m due beyond 12 months. On the other hand, it had cash of AU$1.43m and AU$76.0k worth of receivables due within a year. So it has liabilities totalling AU$6.87m more than its cash and near-term receivables, combined.

While this might seem like a lot, it is not so bad since Nagambie Resources has a market capitalization of AU$24.6m, and so it could probably strengthen its balance sheet by raising capital if it needed to. However, it is still worthwhile taking a close look at its ability to pay off debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is Nagambie Resources's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Given its lack of meaningful operating revenue, investors are probably hoping that Nagambie Resources finds some valuable resources, before it runs out of money.

Caveat Emptor

Over the last twelve months Nagambie Resources produced an earnings before interest and tax (EBIT) loss. Indeed, it lost AU$1.6m at the EBIT level. Considering that alongside the liabilities mentioned above does not give us much confidence that company should be using so much debt. So we think its balance sheet is a little strained, though not beyond repair. However, it doesn't help that it burned through AU$3.0m of cash over the last year. So in short it's a really risky stock. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 6 warning signs for Nagambie Resources you should be aware of, and 3 of them make us uncomfortable.

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.

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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.