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Legendary fund manager Li Lu (who Charlie Munger backed) once said, '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. As with many other companies Dacian Gold Limited (ASX:DCN) makes use of debt. But should shareholders be worried about its use of debt?
When Is Debt Dangerous?
Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. The first step when considering a company's debt levels is to consider its cash and debt together.
What Is Dacian Gold's Net Debt?
The image below, which you can click on for greater detail, shows that Dacian Gold had debt of AU$24.6m at the end of December 2020, a reduction from AU$95.8m over a year. However, it does have AU$28.2m in cash offsetting this, leading to net cash of AU$3.62m.
How Strong Is Dacian Gold's Balance Sheet?
According to the last reported balance sheet, Dacian Gold had liabilities of AU$48.1m due within 12 months, and liabilities of AU$31.6m due beyond 12 months. On the other hand, it had cash of AU$28.2m and AU$4.09m worth of receivables due within a year. So its liabilities total AU$47.4m more than the combination of its cash and short-term receivables.
Since publicly traded Dacian Gold shares are worth a total of AU$284.0m, it seems unlikely that this level of liabilities would be a major threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. While it does have liabilities worth noting, Dacian Gold also has more cash than debt, so we're pretty confident it can manage its debt safely. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Dacian 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.
Over 12 months, Dacian Gold made a loss at the EBIT level, and saw its revenue drop to AU$262m, which is a fall of 4.7%. That's not what we would hope to see.
So How Risky Is Dacian Gold?
We have no doubt that loss making companies are, in general, riskier than profitable ones. And in the last year Dacian Gold had an earnings before interest and tax (EBIT) loss, truth be told. And over the same period it saw negative free cash outflow of AU$8.7m and booked a AU$24m accounting loss. But the saving grace is the AU$3.62m on the balance sheet. That means it could keep spending at its current rate for more than two years. Summing up, we're a little skeptical of this one, as it seems fairly risky in the absence of free cashflow. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 2 warning signs for Dacian Gold you should be aware of, and 1 of them can't be ignored.
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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