Here's Why Azarga Metals (CVE:AZR) Can Afford Some Debt

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We note that Azarga Metals Corp. (CVE:AZR) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

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. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Azarga Metals

What Is Azarga Metals's Net Debt?

The image below, which you can click on for greater detail, shows that Azarga Metals had debt of CA$5.89m at the end of June 2021, a reduction from CA$6.21m over a year. However, it does have CA$1.16m in cash offsetting this, leading to net debt of about CA$4.73m.

How Healthy Is Azarga Metals' Balance Sheet?

We can see from the most recent balance sheet that Azarga Metals had liabilities of CA$132.1k falling due within a year, and liabilities of CA$5.89m due beyond that. Offsetting these obligations, it had cash of CA$1.16m as well as receivables valued at CA$41.1k due within 12 months. So its liabilities total CA$4.82m more than the combination of its cash and short-term receivables.

This deficit is considerable relative to its market capitalization of CA$7.27m, so it does suggest shareholders should keep an eye on Azarga Metals' use of debt. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Azarga Metals will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Since Azarga Metals has no significant operating revenue, shareholders probably hope it will develop a valuable new mine before too long.

Caveat Emptor

Importantly, Azarga Metals had an earnings before interest and tax (EBIT) loss over the last year. To be specific the EBIT loss came in at CA$683k. When we look at that and recall the liabilities on its balance sheet, relative to cash, it seems unwise to us for the company to have any debt. So we think its balance sheet is a little strained, though not beyond repair. Another cause for caution is that is bled CA$958k in negative free cash flow over the last twelve months. So in short it's a really risky stock. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. These risks can be hard to spot. Every company has them, and we've spotted 5 warning signs for Azarga Metals (of which 3 shouldn't be ignored!) you should know about.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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.

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