Warren Buffett said: “Volatility is far from synonymous with risk. It’s natural to consider a company’s balance sheet when looking at its riskiness, as debt is often involved when a company fails. Like many other companies Victoria Gold Corp. (TSE:VGCX) uses debt. But the more important question is: what risk does this debt create?
When is debt a problem?
Generally speaking, debt only becomes a real problem when a company cannot easily repay it, either by raising capital or with its own cash flow. If things go really bad, lenders can take over the business. However, a more common (but still painful) scenario is that it has to raise new equity at a low price, thereby permanently diluting shareholders. Of course, many companies use debt to finance their growth, without any negative consequences. The first thing to do when considering how much debt a business has is to look at its cash and debt together.
Check out our latest analysis for Victoria Gold
What is Victoria Gold’s net debt?
As you can see below, Victoria Gold had C$227.4 million in debt as of September 2021, up from C$264.7 million the previous year. However, he also had C$22.3 million in cash, so his net debt is C$205.2 million.
How strong is Victoria Gold’s balance sheet?
We can see from the most recent balance sheet that Victoria Gold had liabilities of C$115.4 million maturing within one year, and liabilities of C$268.6 million due beyond. In compensation for these obligations, it had cash of 22.3 million Canadian dollars as well as receivables valued at 5.93 million Canadian dollars maturing within 12 months. It therefore has liabilities totaling C$355.8 million more than its cash and short-term receivables, combined.
Victoria Gold has a market capitalization of C$870.3 million, so it could very likely raise funds to improve its balance sheet, should the need arise. But we definitely want to keep our eyes peeled for indications that its debt is too risky.
We use two main ratios to inform us about debt to earnings levels. The first is net debt divided by earnings before interest, taxes, depreciation and amortization (EBITDA), while the second is how often its earnings before interest and taxes (EBIT) covers its interest expense (or its interests, for short). In this way, we consider both the absolute amount of debt, as well as the interest rates paid on it.
With net debt of just 0.94x EBITDA, Victoria Gold is arguably quite conservative. And it has 9.4 times interest coverage, which is more than enough. Even better, Victoria Gold increased its EBIT by 1,442% last year, which is an impressive improvement. This boost will make it even easier to pay off debt in the future. There is no doubt that we learn the most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Victoria Gold’s ability to maintain a healthy balance sheet in the future. So if you want to see what the professionals think, you might find this free analyst earnings forecast report interesting.
Finally, while the taxman may love accounting profits, lenders only accept cash. We therefore always check how much of this EBIT is converted into free cash flow. Over the past two years, Victoria Gold has actually seen a cash outflow, overall. Debt is much riskier for companies with unreliable free cash flow, so shareholders must hope that past spending will produce free cash flow in the future.
Our point of view
On the balance sheet, the most significant positive for Victoria Gold is the fact that it looks capable of growing its EBIT with confidence. But the other factors we noted above weren’t so encouraging. To be precise, it seems about as good at converting EBIT to free cash flow as wet socks are at keeping your feet warm. Looking at all this data, we feel a bit cautious about Victoria Gold’s debt levels. While debt has its upside in higher potential returns, we think shareholders should certainly consider how debt levels could make the stock more risky. When analyzing debt levels, the balance sheet is the obvious starting point. But at the end of the day, every business can contain risks that exist outside of the balance sheet. For example, we have identified 3 warning signs for Victoria Gold of which you should be aware.
In the end, it’s often best to focus on companies that aren’t in debt. You can access our special list of these companies (all with a track record of earnings growth). It’s free.
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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.