Warren Buffett famously said, 'Volatility is far from synonymous with risk.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We note that Gold Resource Corporation (NYSEMKT:GORO) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?
When Is Debt Dangerous?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.
What Is Gold Resource's Net Debt?
The image below, which you can click on for greater detail, shows that Gold Resource had debt of US$2.09m at the end of June 2019, a reduction from US$3.34m over a year. But it also has US$7.94m in cash to offset that, meaning it has US$5.85m net cash.
A Look At Gold Resource's Liabilities
Zooming in on the latest balance sheet data, we can see that Gold Resource had liabilities of US$30.4m due within 12 months and liabilities of US$8.78m due beyond that. On the other hand, it had cash of US$7.94m and US$6.73m worth of receivables due within a year. So its liabilities total US$24.5m more than the combination of its cash and short-term receivables.
Since publicly traded Gold Resource shares are worth a total of US$206.6m, it seems unlikely that this level of liabilities would be a major threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. While it does have liabilities worth noting, Gold Resource also has more cash than debt, so we're pretty confident it can manage its debt safely.
In fact Gold Resource's saving grace is its low debt levels, because its EBIT has tanked 78% in the last twelve months. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Gold Resource's ability to maintain a healthy balance sheet going forward. 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 Gold Resource 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. Over the last three years, Gold Resource saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.
While Gold Resource does have more liabilities than liquid assets, it also has net cash of US$5.9m. So although we see some areas for improvement, we're not too worried about Gold Resource's balance sheet. Given our hesitation about the stock, it would be good to know if Gold Resource insiders have sold any shares recently. You click here to find out if insiders have sold recently.
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.
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