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Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that '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. We can see that Eldorado Gold Corporation (TSE:ELD) does use debt in its business. But should shareholders be worried about its use of debt?
Why Does Debt Bring Risk?
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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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 Eldorado Gold's Debt?
As you can see below, at the end of December 2020, Eldorado Gold had US$501.1m of debt, up from US$479.7m a year ago. Click the image for more detail. But it also has US$511.2m in cash to offset that, meaning it has US$10.1m net cash.
A Look At Eldorado Gold's Liabilities
According to the last reported balance sheet, Eldorado Gold had liabilities of US$262.0m due within 12 months, and liabilities of US$980.5m due beyond 12 months. Offsetting these obligations, it had cash of US$511.2m as well as receivables valued at US$53.7m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$677.7m.
Eldorado Gold has a market capitalization of US$1.91b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution. While it does have liabilities worth noting, Eldorado Gold also has more cash than debt, so we're pretty confident it can manage its debt safely.
Even more impressive was the fact that Eldorado Gold grew its EBIT by 315% over twelve months. If maintained that growth will make the debt even more manageable in the years ahead. 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 Eldorado Gold's ability to maintain a healthy balance sheet going forward. 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. While Eldorado 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. During the last two years, Eldorado Gold produced sturdy free cash flow equating to 56% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.
While Eldorado Gold does have more liabilities than liquid assets, it also has net cash of US$10.1m. And it impressed us with its EBIT growth of 315% over the last year. So we are not troubled with Eldorado Gold's debt use. 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 3 warning signs for Eldorado Gold that you should be aware of before investing here.
When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.
This article by Simply Wall St is general in nature. 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.
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