Is Scorpio Gold (CVE:SGN) Using Debt In A Risky Way?

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 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 Scorpio Gold Corporation (CVE:SGN) does have debt on its balance sheet. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Scorpio Gold

What Is Scorpio Gold's Net Debt?

As you can see below, at the end of June 2023, Scorpio Gold had US$3.76m of debt, up from US$2.30m a year ago. Click the image for more detail. On the flip side, it has US$137.4k in cash leading to net debt of about US$3.63m.

How Healthy Is Scorpio Gold's Balance Sheet?

We can see from the most recent balance sheet that Scorpio Gold had liabilities of US$2.11m falling due within a year, and liabilities of US$8.74m due beyond that. Offsetting these obligations, it had cash of US$137.4k as well as receivables valued at US$8.8k due within 12 months. So it has liabilities totalling US$10.7m more than its cash and near-term receivables, combined.

This deficit casts a shadow over the US$3.84m company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. At the end of the day, Scorpio Gold would probably need a major re-capitalization if its creditors were to demand repayment. 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 Scorpio Gold will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

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

Caveat Emptor

While Scorpio Gold's falling revenue is about as heartwarming as a wet blanket, arguably its earnings before interest and tax (EBIT) loss is even less appealing. Indeed, it lost a very considerable US$3.0m at the EBIT level. Combining this information with the significant liabilities we already touched on makes us very hesitant about this stock, to say the least. Of course, it may be able to improve its situation with a bit of luck and good execution. But we think that is unlikely, given it is low on liquid assets, and burned through US$1.5m in the last year. So we consider this a high risk stock and we wouldn't be at all surprised if the company asks shareholders for money before long. 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. For example - Scorpio Gold has 5 warning signs we think you should be aware of.

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.

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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.