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.' 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. As with many other companies Chembio Diagnostics, Inc. (NASDAQ:CEMI) makes use of debt. But should shareholders be worried about its use of debt?
When Is Debt Dangerous?
Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.
How Much Debt Does Chembio Diagnostics Carry?
The image below, which you can click on for greater detail, shows that Chembio Diagnostics had debt of US$287.4k at the end of June 2019, a reduction from US$426.6k over a year. However, its balance sheet shows it holds US$4.50m in cash, so it actually has US$4.22m net cash.
How Healthy Is Chembio Diagnostics's Balance Sheet?
The latest balance sheet data shows that Chembio Diagnostics had liabilities of US$6.48m due within a year, and liabilities of US$7.64m falling due after that. Offsetting these obligations, it had cash of US$4.50m as well as receivables valued at US$7.73m due within 12 months. So it has liabilities totalling US$1.88m more than its cash and near-term receivables, combined.
This state of affairs indicates that Chembio Diagnostics's balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So it's very unlikely that the US$112.8m company is short on cash, but still worth keeping an eye on the balance sheet. While it does have liabilities worth noting, Chembio Diagnostics also has more cash than debt, so we're pretty confident it can manage its debt safely. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Chembio Diagnostics's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.
In the last year Chembio Diagnostics managed to grow its revenue by 16%, to US$35m. We usually like to see faster growth from unprofitable companies, but each to their own.
So How Risky Is Chembio Diagnostics?
By their very nature companies that are losing money are more risky than those with a long history of profitability. And in the last year Chembio Diagnostics had negative earnings before interest and tax (EBIT), truth be told. And over the same period it saw negative free cash outflow of US$16m and booked a US$11m accounting loss. Given it only has net cash of US$4.5m, the company may need to raise more capital if it doesn't reach break-even soon. Summing up, we're a little skeptical of this one, as it seems fairly risky in the absence of free cashflow. When I consider a company to be a bit risky, I think it is responsible to check out whether insiders have been reporting any share sales. Luckily, you can click here ito see our graphic depicting Chembio Diagnostics insider transactions.
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.
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 email@example.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.