Here's Why Largo (TSE:LGO) Has A Meaningful Debt Burden

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We note that Largo Inc. (TSE:LGO) does have debt on its balance sheet. 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. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Largo

How Much Debt Does Largo Carry?

As you can see below, at the end of December 2022, Largo had US$40.0m of debt, up from US$15.0m a year ago. Click the image for more detail. However, it does have US$54.5m in cash offsetting this, leading to net cash of US$14.5m.

How Healthy Is Largo's Balance Sheet?

According to the last reported balance sheet, Largo had liabilities of US$39.0m due within 12 months, and liabilities of US$42.2m due beyond 12 months. On the other hand, it had cash of US$54.5m and US$21.0m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$5.75m.

Having regard to Largo's size, it seems that its liquid assets are well balanced with its total liabilities. So while it's hard to imagine that the US$289.5m company is struggling for cash, we still think it's worth monitoring its balance sheet. Despite its noteworthy liabilities, Largo boasts net cash, so it's fair to say it does not have a heavy debt load!

In fact Largo's saving grace is its low debt levels, because its EBIT has tanked 91% in the last twelve months. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Largo can strengthen its balance sheet over time. 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. Largo 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 three years, Largo saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.

Summing Up

While it is always sensible to look at a company's total liabilities, it is very reassuring that Largo has US$14.5m in net cash. So while Largo does not have a great balance sheet, it's certainly not too bad. Given our hesitation about the stock, it would be good to know if Largo insiders have sold any shares recently. You click here to find out if insiders have sold recently.

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.