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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. We note that Royal Gold, Inc. (NASDAQ:RGLD) 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 is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. 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 examine debt levels, we first consider both cash and debt levels, together.
How Much Debt Does Royal Gold Carry?
As you can see below, at the end of March 2021, Royal Gold had US$146.3m of debt, up from US$100.2m a year ago. Click the image for more detail. But on the other hand it also has US$370.3m in cash, leading to a US$224.0m net cash position.
How Healthy Is Royal Gold's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Royal Gold had liabilities of US$62.7m due within 12 months and liabilities of US$250.7m due beyond that. Offsetting these obligations, it had cash of US$370.3m as well as receivables valued at US$60.1m due within 12 months. So it actually has US$117.0m more liquid assets than total liabilities.
Having regard to Royal Gold's size, it seems that its liquid assets are well balanced with its total liabilities. So it's very unlikely that the US$7.94b company is short on cash, but still worth keeping an eye on the balance sheet. Succinctly put, Royal Gold boasts net cash, so it's fair to say it does not have a heavy debt load!
In addition to that, we're happy to report that Royal Gold has boosted its EBIT by 34%, thus reducing the spectre of future debt repayments. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Royal 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.
Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While Royal Gold 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, Royal Gold actually produced more free cash flow than EBIT. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.
While it is always sensible to investigate a company's debt, in this case Royal Gold has US$224.0m in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of US$247m, being 119% of its EBIT. So we don't think Royal Gold's use of debt is risky. Over time, share prices tend to follow earnings per share, so if you're interested in Royal Gold, you may well want to click here to check an interactive graph of its earnings per share history.
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.
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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