Amerigo Resources (TSE:ARG) Seems To Use Debt Quite Sensibly

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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. As with many other companies Amerigo Resources Ltd. (TSE:ARG) makes use of debt. But the real question is whether this debt is making the company risky.

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Amerigo Resources

How Much Debt Does Amerigo Resources Carry?

The image below, which you can click on for greater detail, shows that Amerigo Resources had debt of US$27.6m at the end of September 2022, a reduction from US$37.3m over a year. But on the other hand it also has US$43.0m in cash, leading to a US$15.4m net cash position.

A Look At Amerigo Resources' Liabilities

According to the last reported balance sheet, Amerigo Resources had liabilities of US$54.3m due within 12 months, and liabilities of US$61.9m due beyond 12 months. Offsetting this, it had US$43.0m in cash and US$6.27m in receivables that were due within 12 months. So its liabilities total US$66.9m more than the combination of its cash and short-term receivables.

This deficit isn't so bad because Amerigo Resources is worth US$184.8m, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. Despite its noteworthy liabilities, Amerigo Resources boasts net cash, so it's fair to say it does not have a heavy debt load!

The modesty of its debt load may become crucial for Amerigo Resources if management cannot prevent a repeat of the 41% cut to EBIT over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Amerigo 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. Amerigo Resources may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Happily for any shareholders, Amerigo Resources actually produced more free cash flow than EBIT over the last three years. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Summing Up

While Amerigo Resources does have more liabilities than liquid assets, it also has net cash of US$15.4m. And it impressed us with free cash flow of US$24m, being 121% of its EBIT. So we are not troubled with Amerigo Resources's debt use. 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. For example - Amerigo Resources has 2 warning signs we think you should be aware of.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.