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Is Alamos Gold (TSE:AGI) A Risky Investment?

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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.' 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. As with many other companies Alamos Gold Inc. (TSE:AGI) makes use of debt. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Alamos Gold

What Is Alamos Gold's Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2020 Alamos Gold had US$100.0m of debt, an increase on none, over one year. But on the other hand it also has US$314.1m in cash, leading to a US$214.1m net cash position.

debt-equity-history-analysis
debt-equity-history-analysis

How Healthy Is Alamos Gold's Balance Sheet?

We can see from the most recent balance sheet that Alamos Gold had liabilities of US$227.6m falling due within a year, and liabilities of US$619.5m due beyond that. Offsetting these obligations, it had cash of US$314.1m as well as receivables valued at US$41.6m due within 12 months. So it has liabilities totalling US$491.4m more than its cash and near-term receivables, combined.

Of course, Alamos Gold has a market capitalization of US$3.09b, 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. While it does have liabilities worth noting, Alamos Gold also has more cash than debt, so we're pretty confident it can manage its debt safely.

Better yet, Alamos Gold grew its EBIT by 470% last year, which is an impressive improvement. That boost will make it even easier to pay down debt going forward. 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 Alamos 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Alamos Gold may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Over the last three years, Alamos Gold reported free cash flow worth 2.9% of its EBIT, which is really quite low. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.

Summing up

Although Alamos Gold's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of US$214.1m. And it impressed us with its EBIT growth of 470% over the last year. So we don't have any problem with Alamos Gold's use of debt. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 2 warning signs for Alamos Gold you should be aware of.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.