We Think Largo (TSE:LGO) Can Stay On Top Of Its Debt

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, Largo Inc. (TSE:LGO) does carry debt. But should shareholders be worried about its use of debt?

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. 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. 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. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Largo

What Is Largo's Net Debt?

The image below, which you can click on for greater detail, shows that at March 2022 Largo had debt of US$15.0m, up from none in one year. However, its balance sheet shows it holds US$78.4m in cash, so it actually has US$63.4m net cash.

A Look At Largo's Liabilities

We can see from the most recent balance sheet that Largo had liabilities of US$48.4m falling due within a year, and liabilities of US$8.88m due beyond that. Offsetting these obligations, it had cash of US$78.4m as well as receivables valued at US$25.3m due within 12 months. So it can boast US$46.5m more liquid assets than total liabilities.

This short term liquidity is a sign that Largo could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that Largo has more cash than debt is arguably a good indication that it can manage its debt safely.

Even more impressive was the fact that Largo grew its EBIT by 142% over twelve months. That boost will make it even easier to pay down debt going forward. 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.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Largo 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. During the last two years, Largo burned a lot of cash. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is 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$63.4m, as well as more liquid assets than liabilities. And it impressed us with its EBIT growth of 142% over the last year. So we are not troubled with Largo's debt use. Of course, we wouldn't say no to the extra confidence that we'd gain if we knew that Largo insiders have been buying shares: if you're on the same wavelength, you can find out if insiders are buying by clicking this link.

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.