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. Importantly, Citation Growth Corp. (CNSX:CGRO) does carry debt. But should shareholders be worried about its use of debt?
Why Does Debt Bring Risk?
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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
How Much Debt Does Citation Growth Carry?
As you can see below, at the end of June 2019, Citation Growth had CA$7.93m of debt, up from CA$2.54m a year ago. Click the image for more detail. And it doesn't have much cash, so its net debt is about the same.
A Look At Citation Growth's Liabilities
Zooming in on the latest balance sheet data, we can see that Citation Growth had liabilities of CA$13.9m due within 12 months and liabilities of CA$202.0k due beyond that. On the other hand, it had cash of CA$105.0k and CA$203.0k worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by CA$13.8m.
Citation Growth has a market capitalization of CA$41.5m, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution. There's no doubt that we learn most about debt from the balance sheet. But it is Citation Growth's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.
It seems likely shareholders hope that Citation Growth can significantly advance the business plan before too long, because it doesn't have any significant revenue at the moment.
While Citation Growth's falling revenue is about as heartwarming as a wet blanket, arguably its earnings before interest and tax (EBIT) loss is even less appealing. Indeed, it lost a very considerable CA$20m 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. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. Another cause for caution is that is bled CA$13m in negative free cash flow over the last twelve months. So in short it's a really risky stock. For riskier companies like Citation Growth I always like to keep an eye on whether insiders are buying or selling. So click here if you want to find out for yourself.
Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.
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