Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that ‘Volatility is far from synonymous with risk.’ 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, EarthRenew Inc. (CSE:ERTH) does carry debt. But should shareholders be worried about its use of debt?
When Is Debt A Problem?
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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Having said that, the most common situation is where a company manages its debt reasonably well – and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.
Check out our latest analysis for EarthRenew
How Much Debt Does EarthRenew Carry?
The image below, which you can click on for greater detail, shows that at March 2022 EarthRenew had debt of CA$3.96m, up from none in one year. However, it does have CA$675.7k in cash offsetting this, leading to net debt of about CA$3.28m.
How Strong Is EarthRenew’s Balance Sheet?
Zooming in on the latest balance sheet data, we can see that EarthRenew had liabilities of CA$7.86m due within 12 months and liabilities of CA$9.13m due beyond that. Offsetting this, it had CA$675.7k in cash and CA$1.47m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CA$14.8m.
This is a mountain of leverage relative to its market capitalization of CA$23.9m. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry. There’s no doubt that we learn most about debt from the balance sheet. But you can’t view debt in total isolation; since EarthRenew will need earnings to service that debt. So if you’re keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.
In the last year EarthRenew wasn’t profitable at an EBIT level, but managed to grow its revenue by 1,665%, to CA$15m. That’s virtually the hole-in-one of revenue growth!
Even though EarthRenew managed to grow its top line quite deftly, the cold hard truth is that it is losing money on the EBIT line. Indeed, it lost a very considerable CA$4.6m at the EBIT level. When we look at that and recall the liabilities on its balance sheet, relative to cash, it seems unwise to us for the company to have any debt. So we think its balance sheet is a little strained, though not beyond repair. Another cause for caution is that is bled CA$4.0m in negative free cash flow over the last twelve months. So suffice it to say we consider the stock very risky. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. We’ve identified 5 warning signs with EarthRenew (at least 2 which shouldn’t be ignored) , and understanding them should be part of your investment process.
When all is said and done, sometimes its easier to focus on companies that don’t even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.
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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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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