Shanta Gold (LON:SHG) Seems To Use Debt Rather Sparingly

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. We note that Shanta Gold Limited (LON:SHG) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Shanta Gold

What Is Shanta Gold's Debt?

As you can see below, Shanta Gold had US$4.43m of debt at June 2021, down from US$19.0m a year prior. But on the other hand it also has US$24.8m in cash, leading to a US$20.4m net cash position.

How Strong Is Shanta Gold's Balance Sheet?

The latest balance sheet data shows that Shanta Gold had liabilities of US$21.0m due within a year, and liabilities of US$21.4m falling due after that. Offsetting these obligations, it had cash of US$24.8m as well as receivables valued at US$4.28m due within 12 months. So its liabilities total US$13.3m more than the combination of its cash and short-term receivables.

Since publicly traded Shanta Gold shares are worth a total of US$124.7m, it seems unlikely that this level of liabilities would be a major threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. Despite its noteworthy liabilities, Shanta Gold boasts net cash, so it's fair to say it does not have a heavy debt load!

In addition to that, we're happy to report that Shanta Gold has boosted its EBIT by 66%, thus reducing the spectre of future debt repayments. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Shanta Gold's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. Shanta Gold may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. During the last three years, Shanta Gold produced sturdy free cash flow equating to 57% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Summing up

Although Shanta Gold's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of US$20.4m. And we liked the look of last year's 66% year-on-year EBIT growth. So is Shanta Gold's debt a risk? It doesn't seem so to us. 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. For example, we've discovered 3 warning signs for Shanta Gold (1 doesn't sit too well with us!) that you should be aware of before investing here.

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.