Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett said “volatility is far from synonymous with risk.” So it seems smart money knows that debt – which is usually involved in bankruptcies – is a very important factor when you’re assessing a company’s risk. Above all, Osisko Gold Royalties Ltd. (TSE:OR) is in debt. But the more important question is: what risk does this debt create?

When is debt a problem?

Debt helps a business until the business struggles to pay it back, either with new capital or with free cash flow. An integral part of capitalism is the process of “creative destruction” where bankrupt companies are mercilessly liquidated by their bankers. However, a more common (but still costly) situation is when a company has to dilute shareholders at a cheap share price just to keep debt under control. Of course, debt can be an important tool in businesses, especially capital-intensive 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 Osisko Gold Royalties

What is the net debt of Osisko Gold Royalties?

As you can see below, Osisko Gold Royalties had a debt of C$405.3 million, as of September 2021, which is about the same as the previous year. You can click on the graph for more details. However, since it has a cash reserve of C$151.9 million, its net debt is less, at around C$253.4 million.

A look at the liabilities of Osisko Gold Royalties

Zooming in on the latest balance sheet data, we can see that Osisko Gold Royalties had liabilities of C$71.8 million due within 12 months and liabilities of C$506.9 million due beyond. On the other hand, it had liquid assets of 151.9 million Canadian dollars and 16.0 million Canadian dollars of receivables due within one year. Thus, its liabilities outweigh the sum of its cash and (current) receivables of C$410.7 million.

Of course, Osisko Gold Royalties has a market capitalization of C$2.58 billion, so those liabilities are probably manageable. However, we think it’s worth keeping an eye on the strength of its balance sheet, as it can change over time.

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.

Even though Osisko Gold Royalties debt is only 1.8, its interest coverage is really very low at 0.63. A big part of it is that it has so much depreciation and amortization. While companies often boast that these fees are not cash, most of these companies will therefore require an ongoing investment (which is not spent). In any case, there is no doubt that the stock uses significant leverage. We also note that Osisko Gold Royalties improved its EBIT from a loss last year to a positive result of C$12 million. There is no doubt that we learn the most about debt from the balance sheet. But ultimately, the company’s future profitability will decide whether Osisko Gold Royalties can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free analyst earnings forecast report interesting.

But our last consideration is also important, because a company cannot pay debt with paper profits; he needs cash. It is therefore worth checking how much of earnings before interest and tax (EBIT) is supported by free cash flow. Over the past year, Osisko Gold Royalties has experienced significant negative free cash flow, in total. While investors no doubt expect a reversal of this situation in due course, this clearly means that its use of debt is more risky.

Our point of view

At first glance, Osisko Gold Royalties’ interest coverage left us hesitant about the stock, and its EBIT-to-free-cash-flow conversion was no more appealing than the single empty restaurant on the darkest night. busy year. That said, his ability to manage his total liabilities isn’t all that worrying. Once we consider all of the above factors together, it seems to us that Osisko Gold Royalties’ debt makes it a bit risky. This isn’t necessarily a bad thing, but we would generally feel more comfortable with less leverage. There is no doubt that we learn the most about debt from the balance sheet. But at the end of the day, every business can contain risks that exist outside of the balance sheet. To this end, you should be aware of the 1 warning sign we spotted with Osisko Gold Royalties.

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.