The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital. 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. As with many other companies Chaarat Gold Holdings Limited (LON:CGH) makes use of debt. But the real question is whether this debt is making the company risky.
Why Does Debt Bring Risk?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. When we examine debt levels, we first consider both cash and debt levels, together.
How Much Debt Does Chaarat Gold Holdings Carry?
The image below, which you can click on for greater detail, shows that at June 2019 Chaarat Gold Holdings had debt of US$82.0m, up from US$21.5m in one year. However, because it has a cash reserve of US$4.91m, its net debt is less, at about US$77.1m.
How Strong Is Chaarat Gold Holdings's Balance Sheet?
According to the last reported balance sheet, Chaarat Gold Holdings had liabilities of US$66.4m due within 12 months, and liabilities of US$45.8m due beyond 12 months. Offsetting this, it had US$4.91m in cash and US$15.3m in receivables that were due within 12 months. So it has liabilities totalling US$91.9m more than its cash and near-term receivables, combined.
Chaarat Gold Holdings has a market capitalization of US$217.0m, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Chaarat Gold Holdings can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.
In the last year Chaarat Gold Holdings managed to produce its first revenue as a listed company, but given the lack of profit, shareholders will no doubt be hoping to see some strong increases.
Over the last twelve months Chaarat Gold Holdings produced an earnings before interest and tax (EBIT) loss. Indeed, it lost US$14m at the EBIT level. 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. However, it doesn't help that it burned through US$16m of cash over the last year. So in short it's a really risky stock. When I consider a company to be a bit risky, I think it is responsible to check out whether insiders have been reporting any share sales. Luckily, you can click here ito see our graphic depicting Chaarat Gold Holdings insider transactions.
If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.
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