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Health Check: How Prudently Does Galane Gold (CVE:GG) Use Debt?

Simply Wall St

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.' 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. Importantly, Galane Gold Ltd. (CVE:GG) does carry debt. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own 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, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Galane Gold

What Is Galane Gold's Net Debt?

As you can see below, at the end of June 2019, Galane Gold had US$17.7m of debt, up from US$14.8m a year ago. Click the image for more detail. However, it also had US$3.84m in cash, and so its net debt is US$13.9m.

TSXV:GG Historical Debt, August 19th 2019

How Healthy Is Galane Gold's Balance Sheet?

The latest balance sheet data shows that Galane Gold had liabilities of US$17.3m due within a year, and liabilities of US$19.1m falling due after that. Offsetting these obligations, it had cash of US$3.84m as well as receivables valued at US$1.00m due within 12 months. So its liabilities total US$31.6m more than the combination of its cash and short-term receivables.

The deficiency here weighs heavily on the US$12.1m company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we definitely think shareholders need to watch this one closely. After all, Galane Gold would likely require a major re-capitalisation if it had to pay its creditors today. There's no doubt that we learn most about debt from the balance sheet. But it is Galane Gold's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Over 12 months, Galane Gold saw its revenue drop to US$41m, which is a fall of 8.7%. We would much prefer see growth.

Caveat Emptor

Over the last twelve months Galane Gold produced an earnings before interest and tax (EBIT) loss. Indeed, it lost a very considerable US$2.5m at the EBIT level. Combining this information with the significant liabilities we already touched on makes us very hesitant about this stock, to say the least. Of course, it may be able to improve its situation with a bit of luck and good execution. But we think that is unlikely, given it is low on liquid assets, and burned through US$3.6m in the last year. So we consider this a high risk stock and we wouldn't be at all surprised if the company asks shareholders for money before long. For riskier companies like Galane Gold I always like to keep an eye on whether insiders are buying or selling. So click here if you want to find out for yourself.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. 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. Simply Wall St has no position in the stocks mentioned. Thank you for reading.