Stock Analysis

Royal Gold (NASDAQ:RGLD) Seems To Use Debt Quite Sensibly

NasdaqGS:RGLD
Source: Shutterstock

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.' 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, Royal Gold, Inc. (NASDAQ:RGLD) does carry debt. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

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 examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Royal Gold

What Is Royal Gold's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2022 Royal Gold had US$446.3m of debt, an increase on US$95.4m, over one year. On the flip side, it has US$122.2m in cash leading to net debt of about US$324.1m.

debt-equity-history-analysis
NasdaqGS:RGLD Debt to Equity History December 21st 2022

How Strong Is Royal Gold's Balance Sheet?

We can see from the most recent balance sheet that Royal Gold had liabilities of US$64.5m falling due within a year, and liabilities of US$592.4m due beyond that. On the other hand, it had cash of US$122.2m and US$43.5m worth of receivables due within a year. So its liabilities total US$491.1m more than the combination of its cash and short-term receivables.

Of course, Royal Gold has a market capitalization of US$7.25b, so these liabilities are probably manageable. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Royal Gold has a low net debt to EBITDA ratio of only 0.65. And its EBIT easily covers its interest expense, being 254 times the size. So we're pretty relaxed about its super-conservative use of debt. But the other side of the story is that Royal Gold saw its EBIT decline by 4.1% over the last year. That sort of decline, if sustained, will obviously make debt harder to handle. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Royal Gold 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, Royal Gold saw substantial negative free cash flow, in total. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Our View

Royal Gold's conversion of EBIT to free cash flow was a real negative on this analysis, although the other factors we considered were considerably better. There's no doubt that its ability to to cover its interest expense with its EBIT is pretty flash. Looking at all this data makes us feel a little cautious about Royal Gold's debt levels. While debt does have its upside in higher potential returns, we think shareholders should definitely consider how debt levels might make the stock more risky. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. For example, we've discovered 2 warning signs for Royal Gold (1 makes us a bit uncomfortable!) that you should be aware of before investing here.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

New: AI Stock Screener & Alerts

Our new AI Stock Screener scans the market every day to uncover opportunities.

• Dividend Powerhouses (3%+ Yield)
• Undervalued Small Caps with Insider Buying
• High growth Tech and AI Companies

Or build your own from over 50 metrics.

Explore Now for 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.