We Think Amerigo Resources (TSE:ARG) Can Manage Its Debt With Ease

Warren Buffett famously said, '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 can see that Amerigo Resources Ltd. (TSE:ARG) does use debt in its business. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Amerigo Resources

What Is Amerigo Resources's Net Debt?

You can click the graphic below for the historical numbers, but it shows that Amerigo Resources had US$30.8m of debt in March 2022, down from US$48.9m, one year before. However, its balance sheet shows it holds US$71.5m in cash, so it actually has US$40.7m net cash.

How Healthy Is Amerigo Resources' Balance Sheet?

According to the last reported balance sheet, Amerigo Resources had liabilities of US$63.5m due within 12 months, and liabilities of US$71.5m due beyond 12 months. Offsetting these obligations, it had cash of US$71.5m as well as receivables valued at US$13.7m due within 12 months. So it has liabilities totalling US$49.8m more than its cash and near-term receivables, combined.

While this might seem like a lot, it is not so bad since Amerigo Resources has a market capitalization of US$159.4m, 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. Despite its noteworthy liabilities, Amerigo 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 Amerigo Resources grew its EBIT by 107% 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 it is future earnings, more than anything, that will determine Amerigo Resources's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

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. Over the last two years, Amerigo Resources actually produced more free cash flow than EBIT. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Summing up

Although Amerigo Resources's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of US$40.7m. And it impressed us with free cash flow of US$73m, being 116% of its EBIT. So is Amerigo 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 Amerigo Resources has 4 warning signs (and 1 which doesn't sit too well with us) we think you should know about.

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.