Is New Gold (TSE:NGD) Using Too Much Debt?

Warren Buffett famously said, '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. As with many other companies New Gold Inc. (TSE:NGD) makes use of debt. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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 New Gold

What Is New Gold's Debt?

The chart below, which you can click on for greater detail, shows that New Gold had US$396.0m in debt in December 2023; about the same as the year before. On the flip side, it has US$192.6m in cash leading to net debt of about US$203.4m.

A Look At New Gold's Liabilities

The latest balance sheet data shows that New Gold had liabilities of US$229.0m due within a year, and liabilities of US$1.27b falling due after that. On the other hand, it had cash of US$192.6m and US$17.1m worth of receivables due within a year. So its liabilities total US$1.29b more than the combination of its cash and short-term receivables.

Given this deficit is actually higher than the company's market capitalization of US$1.14b, we think shareholders really should watch New Gold's debt levels, like a parent watching their child ride a bike for the first time. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price.

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). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

New Gold has a low debt to EBITDA ratio of only 0.70. But the really cool thing is that it actually managed to receive more interest than it paid, over the last year. So it's fair to say it can handle debt like a hotshot teppanyaki chef handles cooking. Although New Gold made a loss at the EBIT level, last year, it was also good to see that it generated US$57m in EBIT over the last twelve months. 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 New Gold's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So it's worth checking how much of the earnings before interest and tax (EBIT) is backed by free cash flow. In the last year, New Gold's free cash flow amounted to 38% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Our View

New Gold's level of total liabilities and conversion of EBIT to free cash flow definitely weigh on it, in our esteem. But its interest cover tells a very different story, and suggests some resilience. When we consider all the factors discussed, it seems to us that New Gold is taking some risks with its use of debt. While that debt can boost returns, we think the company has enough leverage now. Given our hesitation about the stock, it would be good to know if New Gold insiders have sold any shares recently. You click here to find out if insiders have sold recently.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.