Is Fortuna Silver Mines (TSE:FVI) Using Too Much Debt?

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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. Importantly, Fortuna Silver Mines Inc. (TSE:FVI) does carry debt. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

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. If things get really bad, the lenders can take control of the business. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, 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 at March 2019 Fortuna Silver Mines had debt of US$69.8m, up from US$40.1m in one year. However, its balance sheet shows it holds US$112.9m in cash, so it actually has US$43.1m net cash.

TSX:FVI Historical Debt, July 1st 2019
TSX:FVI Historical Debt, July 1st 2019

How Healthy Is Fortuna Silver Mines’s Balance Sheet?

We can see from the most recent balance sheet that Fortuna Silver Mines had liabilities of US$65.0m falling due within a year, and liabilities of US$125.8m due beyond that. Offsetting this, it had US$112.9m in cash and US$37.1m in receivables that were due within 12 months. So it has liabilities totalling US$40.7m more than its cash and near-term receivables, combined.

Since publicly traded Fortuna Silver Mines shares are worth a total of US$456.7m, it seems unlikely that this level of liabilities would be a major threat. Having said that, it’s clear that we should continue to monitor its balance sheet, lest it change for the worse. Fortuna Silver Mines boasts net cash, so it’s fair to say it does not have a heavy debt load!

The modesty of its debt load may become crucial for Fortuna Silver Mines if management cannot prevent a repeat of the 44% cut to EBIT over the last year. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. When analysing debt levels, the balance sheet is the obvious place to start. 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. While Fortuna Silver Mines has net cash on its balance sheet, it’s still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Considering the last three years, Fortuna Silver Mines actually recorded a cash outflow, overall. Debt is usually more expensive, and almost always more risky in the hands of a company with negative free cash flow. Shareholders ought to hope for and improvement.

Summing up

While it is always sensible to look at a company’s total liabilities, it is very reassuring that Fortuna Silver Mines has US$43m in net cash. So although we see some areas for improvement, we’re not too worried about Fortuna Silver Mines’s balance sheet. Given our hesitation about the stock, it would be good to know if Fortuna Silver Mines insiders have sold any shares recently. You click here to find out if insiders have sold recently.

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.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.