We Think Shanta Gold (LON:SHG) Is Taking Some Risk With Its Debt

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. Importantly, Shanta Gold Limited (LON:SHG) does carry debt. 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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Shanta Gold

How Much Debt Does Shanta Gold Carry?

As you can see below, Shanta Gold had US$6.28m of debt at December 2021, down from US$18.2m a year prior. However, its balance sheet shows it holds US$13.2m in cash, so it actually has US$6.94m net cash.

How Strong Is Shanta Gold's Balance Sheet?

We can see from the most recent balance sheet that Shanta Gold had liabilities of US$25.4m falling due within a year, and liabilities of US$23.3m due beyond that. On the other hand, it had cash of US$13.2m and US$7.05m worth of receivables due within a year. So its liabilities total US$28.5m more than the combination of its cash and short-term receivables.

Shanta Gold has a market capitalization of US$120.6m, 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. Despite its noteworthy liabilities, Shanta Gold boasts net cash, so it's fair to say it does not have a heavy debt load!

Importantly, Shanta Gold's EBIT fell a jaw-dropping 89% in the last twelve months. If that decline continues then paying off debt will be harder than selling foie gras at a vegan convention. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Shanta Gold 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Shanta Gold has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Looking at the most recent three years, Shanta Gold recorded free cash flow of 29% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

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$6.94m. Despite its cash we think that Shanta Gold seems to struggle to grow its EBIT, so we are wary of the stock. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. For example, we've discovered 2 warning signs for Shanta Gold (1 can't be ignored!) that you should be aware of before investing here.

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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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.