Pan American Silver (TSE:PAAS) Has A Pretty Healthy Balance Sheet

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 seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We note that Pan American Silver Corp. (TSE:PAAS) does have debt on its balance sheet. But is this debt a concern to shareholders?

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. If things get really bad, the lenders can take control of the business. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Pan American Silver

What Is Pan American Silver's Net Debt?

The image below, which you can click on for greater detail, shows that at June 2023 Pan American Silver had debt of US$1.04b, up from US$51.5m in one year. However, it also had US$409.2m in cash, and so its net debt is US$629.8m.

How Strong Is Pan American Silver's Balance Sheet?

We can see from the most recent balance sheet that Pan American Silver had liabilities of US$658.3m falling due within a year, and liabilities of US$2.89b due beyond that. Offsetting these obligations, it had cash of US$409.2m as well as receivables valued at US$218.2m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$2.93b.

Pan American Silver has a market capitalization of US$5.68b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). 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).

Given net debt is only 1.4 times EBITDA, it is initially surprising to see that Pan American Silver's EBIT has low interest coverage of 0.40 times. So while we're not necessarily alarmed we think that its debt is far from trivial. Importantly, Pan American Silver grew its EBIT by 42% over the last twelve months, and that growth will make it easier to handle its debt. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Pan American Silver'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 company can only pay off debt with cold hard cash, not accounting profits. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. In the last three years, Pan American Silver's free cash flow amounted to 47% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Our View

Based on what we've seen Pan American Silver is not finding it easy, given its interest cover, but the other factors we considered give us cause to be optimistic. There's no doubt that its ability to to grow its EBIT is pretty flash. When we consider all the factors mentioned above, we do feel a bit cautious about Pan American Silver's use of debt. While debt does have its upside in higher potential returns, we think shareholders should definitely consider how debt levels might make the stock more risky. 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. Case in point: We've spotted 2 warning signs for Pan American Silver you should be aware of.

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.