Scotgold Resources (LON:SGZ) Is Carrying A Fair Bit Of 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.' 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. Importantly, Scotgold Resources Limited (LON:SGZ) does carry debt. But is this debt a concern to shareholders?

When Is Debt Dangerous?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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.

See our latest analysis for Scotgold Resources

How Much Debt Does Scotgold Resources Carry?

You can click the graphic below for the historical numbers, but it shows that as of June 2021 Scotgold Resources had AU$19.9m of debt, an increase on AU$7.68m, over one year. However, it also had AU$2.62m in cash, and so its net debt is AU$17.3m.

How Healthy Is Scotgold Resources' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Scotgold Resources had liabilities of AU$11.1m due within 12 months and liabilities of AU$12.9m due beyond that. On the other hand, it had cash of AU$2.62m and AU$448.3k worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by AU$20.9m.

While this might seem like a lot, it is not so bad since Scotgold Resources has a market capitalization of AU$75.6m, and so it could probably strengthen its balance sheet by raising capital if it needed to. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Scotgold Resources'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.

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

Caveat Emptor

Over the last twelve months Scotgold Resources produced an earnings before interest and tax (EBIT) loss. Indeed, it lost AU$3.9m at the EBIT level. Considering that alongside the liabilities mentioned above does not give us much confidence that company should be using so much debt. So we think its balance sheet is a little strained, though not beyond repair. Another cause for caution is that is bled AU$13m in negative free cash flow over the last twelve months. So in short it's a really risky stock. The balance sheet is clearly the area to focus on when you are analysing debt. 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 6 warning signs for Scotgold Resources (of which 2 can'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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.