Does Amerigo Resources (TSE:ARG) Have A Healthy Balance Sheet?

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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We can see that Amerigo Resources Ltd. (TSE:ARG) does use debt in its business. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

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. 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. 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.

See our latest analysis for Amerigo Resources

How Much Debt Does Amerigo Resources Carry?

You can click the graphic below for the historical numbers, but it shows that Amerigo Resources had US$38.1m of debt in June 2021, down from US$53.6m, one year before. But it also has US$48.9m in cash to offset that, meaning it has US$10.8m net cash.

A Look At Amerigo Resources' Liabilities

According to the last reported balance sheet, Amerigo Resources had liabilities of US$53.6m due within 12 months, and liabilities of US$71.9m due beyond 12 months. On the other hand, it had cash of US$48.9m and US$12.6m worth of receivables due within a year. So it has liabilities totalling US$64.0m more than its cash and near-term receivables, combined.

Amerigo Resources has a market capitalization of US$189.8m, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt. Despite its noteworthy liabilities, Amerigo Resources boasts net cash, so it's fair to say it does not have a heavy debt load!

It was also good to see that despite losing money on the EBIT line last year, Amerigo Resources turned things around in the last 12 months, delivering and EBIT of US$55m. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Amerigo Resources will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs 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 year. 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$10.8m. And it impressed us with free cash flow of US$67m, being 123% of its EBIT. So we don't have any problem with Amerigo Resources's use of debt. We'd be motivated to research the stock further if we found out that Amerigo Resources insiders have bought shares recently. If you would too, then you're in luck, since today we're sharing our list of reported insider transactions for free.

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.

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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.
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