Is China Gold International Resources (TSE:CGG) A Risky Investment?

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We can see that China Gold International Resources Corp. Ltd. (TSE:CGG) does use debt in its business. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for China Gold International Resources

What Is China Gold International Resources's Debt?

The image below, which you can click on for greater detail, shows that China Gold International Resources had debt of US$975.9m at the end of March 2022, a reduction from US$1.18b over a year. However, because it has a cash reserve of US$354.1m, its net debt is less, at about US$621.8m.

How Healthy Is China Gold International Resources' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that China Gold International Resources had liabilities of US$459.1m due within 12 months and liabilities of US$1.08b due beyond that. Offsetting these obligations, it had cash of US$354.1m as well as receivables valued at US$11.8m due within 12 months. So its liabilities total US$1.18b more than the combination of its cash and short-term receivables.

This deficit is considerable relative to its market capitalization of US$1.19b, so it does suggest shareholders should keep an eye on China Gold International Resources' use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

China Gold International Resources's net debt is only 1.2 times its EBITDA. And its EBIT easily covers its interest expense, being 13.6 times the size. So we're pretty relaxed about its super-conservative use of debt. In addition to that, we're happy to report that China Gold International Resources has boosted its EBIT by 61%, thus reducing the spectre of future debt repayments. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if China Gold International Resources can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. Happily for any shareholders, China Gold International Resources actually produced more free cash flow than EBIT over the last three years. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Our View

China Gold International Resources's interest cover suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. But we must concede we find its level of total liabilities has the opposite effect. When we consider the range of factors above, it looks like China Gold International Resources is pretty sensible with its use of debt. While that brings some risk, it can also enhance returns for shareholders. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. Be aware that China Gold International Resources is showing 1 warning sign in our investment analysis , you should know about...

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.