Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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. As with many other companies Golden Energy and Resources Limited (SGX:AUE) makes use of debt. But is this debt a concern to shareholders?
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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.
What Is Golden Energy and Resources's Debt?
The image below, which you can click on for greater detail, shows that at June 2021 Golden Energy and Resources had debt of US$406.8m, up from US$359.7m in one year. However, it also had US$249.8m in cash, and so its net debt is US$157.0m.
A Look At Golden Energy and Resources' Liabilities
The latest balance sheet data shows that Golden Energy and Resources had liabilities of US$368.8m due within a year, and liabilities of US$492.8m falling due after that. Offsetting these obligations, it had cash of US$249.8m as well as receivables valued at US$194.5m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$417.2m.
This is a mountain of leverage relative to its market capitalization of US$535.1m. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.
We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.
While Golden Energy and Resources's low debt to EBITDA ratio of 0.71 suggests only modest use of debt, the fact that EBIT only covered the interest expense by 6.0 times last year does give us pause. So we'd recommend keeping a close eye on the impact financing costs are having on the business. Importantly, Golden Energy and Resources grew its EBIT by 74% over the last twelve months, and that growth will make it easier to handle its debt. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Golden Energy and Resources can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.
Finally, a company can only pay off debt with cold hard cash, not accounting profits. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Over the last three years, Golden Energy and Resources recorded free cash flow worth a fulsome 85% of its EBIT, which is stronger than we'd usually expect. That positions it well to pay down debt if desirable to do so.
The good news is that Golden Energy and Resources's demonstrated ability to convert EBIT to free cash flow delights us like a fluffy puppy does a toddler. But, on a more sombre note, we are a little concerned by its level of total liabilities. When we consider the range of factors above, it looks like Golden Energy and Resources is pretty sensible with its use of debt. While that brings some risk, it can also enhance returns for shareholders. 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 Golden Energy and Resources (1 is a bit unpleasant!) 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.