Here's Why Equinox Gold (TSE:EQX) Is Weighed Down By Its Debt Load

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.' 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. As with many other companies Equinox Gold Corp. (TSE:EQX) makes use of debt. But the real question is whether this debt is making the company risky.

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. 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. 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 Equinox Gold

What Is Equinox Gold's Net Debt?

As you can see below, at the end of September 2022, Equinox Gold had US$725.8m of debt, up from US$545.1m a year ago. Click the image for more detail. However, it does have US$212.0m in cash offsetting this, leading to net debt of about US$513.8m.

How Healthy Is Equinox Gold's Balance Sheet?

The latest balance sheet data shows that Equinox Gold had liabilities of US$221.9m due within a year, and liabilities of US$1.16b falling due after that. Offsetting this, it had US$212.0m in cash and US$79.5m in receivables that were due within 12 months. So it has liabilities totalling US$1.09b more than its cash and near-term receivables, combined.

When you consider that this deficiency exceeds the company's US$1.03b market capitalization, you might well be inclined to review the balance sheet intently. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). 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).

Even though Equinox Gold's debt is only 2.0, its interest cover is really very low at 2.4. In large part that's it has so much depreciation and amortisation. These charges may be non-cash, so they could be excluded when it comes to paying down debt. But the accounting charges are there for a reason -- some assets are seen to be losing value. In any case, it's safe to say the company has meaningful debt. Shareholders should be aware that Equinox Gold's EBIT was down 23% last year. If that earnings trend continues then paying off its debt will be about as easy as herding cats on to a roller coaster. 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 Equinox Gold's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So it's worth checking how much of that EBIT is backed by free cash flow. During the last three years, Equinox Gold burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

On the face of it, Equinox Gold's conversion of EBIT to free cash flow left us tentative about the stock, and its EBIT growth rate was no more enticing than the one empty restaurant on the busiest night of the year. But at least its net debt to EBITDA is not so bad. Taking into account all the aforementioned factors, it looks like Equinox Gold has too much debt. While some investors love that sort of risky play, it's certainly not our cup of tea. Given the risks around Equinox Gold's use of debt, the sensible thing to do is to check if insiders have been unloading the stock.

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.