Is Penta Gold (NSE:PENTAGOLD) 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. Importantly, Penta Gold Limited (NSE:PENTAGOLD) does carry debt. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. If things get really bad, the lenders can take control of the business. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Penta Gold

What Is Penta Gold's Net Debt?

The chart below, which you can click on for greater detail, shows that Penta Gold had ₹1.22b in debt in March 2022; about the same as the year before. Net debt is about the same, since the it doesn't have much cash.

How Healthy Is Penta Gold's Balance Sheet?

We can see from the most recent balance sheet that Penta Gold had liabilities of ₹3.99b falling due within a year, and liabilities of ₹17.2m due beyond that. On the other hand, it had cash of ₹1.55m and ₹1.65b worth of receivables due within a year. So its liabilities total ₹2.36b more than the combination of its cash and short-term receivables.

Given this deficit is actually higher than the company's market capitalization of ₹1.93b, we think shareholders really should watch Penta Gold's debt levels, like a parent watching their child ride a bike for the first time. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer extensive dilution. There's no doubt that we learn most about debt from the balance sheet. But it is Penta Gold's earnings that will influence how the balance sheet holds up in the future. 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.

Over 12 months, Penta Gold made a loss at the EBIT level, and saw its revenue drop to ₹1.1m, which is a fall of 100%. That makes us nervous, to say the least.

Caveat Emptor

While Penta 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. To be specific the EBIT loss came in at ₹81m. Considering that alongside the liabilities mentioned above make us nervous about the company. We'd want to see some strong near-term improvements before getting too interested in the stock. Not least because it had negative free cash flow of ₹3.3m over the last twelve months. That means it's on the risky side of things. 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. To that end, you should learn about the 5 warning signs we've spotted with Penta Gold (including 4 which are concerning) .

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.