Fortuna Silver Mines (TSE:FVI) Seems To Use Debt Quite Sensibly

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. As with many other companies Fortuna Silver Mines Inc. (TSE:FVI) makes use of debt. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

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. 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. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Fortuna Silver Mines

How Much Debt Does Fortuna Silver Mines Carry?

The image below, which you can click on for greater detail, shows that Fortuna Silver Mines had debt of US$206.8m at the end of December 2023, a reduction from US$219.2m over a year. However, it also had US$128.1m in cash, and so its net debt is US$78.7m.

How Healthy Is Fortuna Silver Mines' Balance Sheet?

The latest balance sheet data shows that Fortuna Silver Mines had liabilities of US$243.8m due within a year, and liabilities of US$436.0m falling due after that. Offsetting this, it had US$128.1m in cash and US$69.5m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$482.1m.

Fortuna Silver Mines has a market capitalization of US$1.51b, so it could very likely raise cash to ameliorate 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.

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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Looking at its net debt to EBITDA of 0.24 and interest cover of 7.0 times, it seems to us that Fortuna Silver Mines is probably using debt in a pretty reasonable way. But the interest payments are certainly sufficient to have us thinking about how affordable its debt is. It was also good to see that despite losing money on the EBIT line last year, Fortuna Silver Mines turned things around in the last 12 months, delivering and EBIT of US$43m. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Fortuna Silver Mines'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.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it is important to check how much of its earnings before interest and tax (EBIT) converts to actual free cash flow. Over the last year, Fortuna Silver Mines actually produced more free cash flow than EBIT. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Our View

Happily, Fortuna Silver Mines's impressive conversion of EBIT to free cash flow implies it has the upper hand on its debt. And the good news does not stop there, as its net debt to EBITDA also supports that impression! When we consider the range of factors above, it looks like Fortuna Silver Mines is pretty sensible with its use of debt. While that brings some risk, it can also enhance returns for shareholders. 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 - Fortuna Silver Mines 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.

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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.