Health Check: How Prudently Does Gowest Gold (CVE:GWA) Use Debt?

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 Gowest Gold Ltd. (CVE:GWA) makes use of debt. But is this debt a concern to shareholders?

When Is Debt Dangerous?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out the opportunities and risks within the CA Metals and Mining industry.

What Is Gowest Gold's Net Debt?

You can click the graphic below for the historical numbers, but it shows that Gowest Gold had CA$6.10m of debt in July 2022, down from CA$21.5m, one year before. However, because it has a cash reserve of CA$4.83m, its net debt is less, at about CA$1.28m.

A Look At Gowest Gold's Liabilities

We can see from the most recent balance sheet that Gowest Gold had liabilities of CA$14.6m falling due within a year, and liabilities of CA$5.30m due beyond that. On the other hand, it had cash of CA$4.83m and CA$64.9k worth of receivables due within a year. So it has liabilities totalling CA$15.0m more than its cash and near-term receivables, combined.

This deficit is considerable relative to its market capitalization of CA$18.0m, so it does suggest shareholders should keep an eye on Gowest Gold's use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Gowest Gold 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.

Given its lack of meaningful operating revenue, investors are probably hoping that Gowest Gold finds some valuable resources, before it runs out of money.

Caveat Emptor

Importantly, Gowest Gold had an earnings before interest and tax (EBIT) loss over the last year. To be specific the EBIT loss came in at CA$709k. 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. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. Another cause for caution is that is bled CA$4.5m in negative free cash flow over the last twelve months. So in short it's a really risky stock. 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 Gowest Gold is showing 5 warning signs in our investment analysis , and 4 of those are significant...

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.