Is Largo (TSE:LGO) A Risky Investment?

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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. As with many other companies Largo Inc. (TSE:LGO) makes use of debt. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. If things get really bad, the lenders can take control of the business. 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. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Largo

How Much Debt Does Largo Carry?

The image below, which you can click on for greater detail, shows that Largo had debt of US$15.0m at the end of December 2021, a reduction from US$24.8m over a year. However, it does have US$83.8m in cash offsetting this, leading to net cash of US$68.8m.

A Look At Largo's Liabilities

We can see from the most recent balance sheet that Largo had liabilities of US$41.7m falling due within a year, and liabilities of US$6.54m due beyond that. On the other hand, it had cash of US$83.8m and US$23.7m worth of receivables due within a year. So it can boast US$59.3m more liquid assets than total liabilities.

This surplus suggests that Largo has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, Largo boasts net cash, so it's fair to say it does not have a heavy debt load!

In addition to that, we're happy to report that Largo has boosted its EBIT by 89%, thus reducing the spectre of future debt repayments. 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 want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs 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 two 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 we empathize with investors who find debt concerning, you should keep in mind that Largo has net cash of US$68.8m, as well as more liquid assets than liabilities. And we liked the look of last year's 89% year-on-year EBIT growth. So we are not troubled with Largo's debt use. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that Largo is showing 2 warning signs in our investment analysis , you should know about...

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.