Is Patagonia Gold (CVE:PGDC) A Risky Investment?

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.' 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. We can see that Patagonia Gold Corp. (CVE:PGDC) does use debt in its business. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

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. If things get really bad, the lenders can take control of the business. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for Patagonia Gold

What Is Patagonia Gold's Debt?

As you can see below, Patagonia Gold had US$18.2m of debt at March 2021, down from US$26.7m a year prior. However, because it has a cash reserve of US$1.12m, its net debt is less, at about US$17.1m.

How Healthy Is Patagonia Gold's Balance Sheet?

According to the last reported balance sheet, Patagonia Gold had liabilities of US$8.37m due within 12 months, and liabilities of US$24.3m due beyond 12 months. Offsetting this, it had US$1.12m in cash and US$2.72m in receivables that were due within 12 months. So it has liabilities totalling US$28.8m more than its cash and near-term receivables, combined.

Given this deficit is actually higher than the company's market capitalization of US$22.4m, we think shareholders really should watch Patagonia 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. When analysing debt levels, the balance sheet is the obvious place to start. But it is Patagonia Gold's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Over 12 months, Patagonia Gold made a loss at the EBIT level, and saw its revenue drop to US$20m, which is a fall of 8.5%. That's not what we would hope to see.

Caveat Emptor

Importantly, Patagonia Gold had an earnings before interest and tax (EBIT) loss over the last year. Its EBIT loss was a whopping US$2.4m. Considering that alongside the liabilities mentioned above make us nervous about the company. It would need to improve its operations quickly for us to be interested in it. Not least because it burned through US$3.4m in negative free cash flow over the last year. So suffice it to say we consider the stock to be risky. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. We've identified 5 warning signs with Patagonia Gold (at least 2 which are a bit concerning) , and understanding them should be part of your investment process.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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