David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' 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. Importantly, Fortuna Silver Mines Inc. (TSE:FVI) does carry debt. But the real question is whether this debt is making the company risky.
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. 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, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.
What Is Fortuna Silver Mines's Net Debt?
You can click the graphic below for the historical numbers, but it shows that as of March 2019 Fortuna Silver Mines had US$69.8m of debt, an increase on US$40.1m, over one year. But it also has US$112.9m in cash to offset that, meaning it has US$43.1m net cash.
How Strong Is Fortuna Silver Mines's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Fortuna Silver Mines had liabilities of US$65.0m due within 12 months and liabilities of US$125.8m due beyond that. Offsetting these obligations, it had cash of US$112.9m as well as receivables valued at US$37.1m due within 12 months. So its liabilities total US$40.7m more than the combination of its cash and short-term receivables.
Of course, Fortuna Silver Mines has a market capitalization of US$632.8m, so these liabilities are probably manageable. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. While it does have liabilities worth noting, Fortuna Silver Mines also has more cash than debt, so we're pretty confident it can manage its debt safely.
It is just as well that Fortuna Silver Mines's load is not too heavy, because its EBIT was down 44% over the last year. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. 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 Fortuna Silver Mines can strengthen its balance sheet over time. 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. Fortuna Silver Mines 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. Considering the last three years, Fortuna Silver Mines actually recorded a cash outflow, overall. Debt is far more risky for companies with unreliable free cash flow, so shareholders should be hoping that the past expenditure will produce free cash flow in the future.
We could understand if investors are concerned about Fortuna Silver Mines's liabilities, but we can be reassured by the fact it has has net cash of US$43m. So while Fortuna Silver Mines does not have a great balance sheet, it's certainly not too bad. In light of our reservations about the company's balance sheet, it seems sensible to check if insiders have been selling shares recently.
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.
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