Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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. We can see that Corero Network Security plc (LON:CNS) does use debt in its business. But is this debt a concern to shareholders?
When Is Debt A Problem?
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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.
How Much Debt Does Corero Network Security Carry?
You can click the graphic below for the historical numbers, but it shows that Corero Network Security had US$2.88m of debt in June 2020, down from US$3.24m, one year before. However, its balance sheet shows it holds US$6.22m in cash, so it actually has US$3.34m net cash.
How Strong Is Corero Network Security's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Corero Network Security had liabilities of US$7.45m due within 12 months and liabilities of US$3.03m due beyond that. Offsetting these obligations, it had cash of US$6.22m as well as receivables valued at US$2.39m due within 12 months. So it has liabilities totalling US$1.87m more than its cash and near-term receivables, combined.
Of course, Corero Network Security has a market capitalization of US$61.5m, so these liabilities are probably manageable. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. Despite its noteworthy liabilities, Corero Network Security boasts net cash, so it's fair to say it does not have a heavy debt load! When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Corero Network Security can strengthen its balance sheet over time. 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 Corero Network Security wasn't profitable at an EBIT level, but managed to grow its revenue by 29%, to US$12m. With any luck the company will be able to grow its way to profitability.
So How Risky Is Corero Network Security?
We have no doubt that loss making companies are, in general, riskier than profitable ones. And the fact is that over the last twelve months Corero Network Security lost money at the earnings before interest and tax (EBIT) line. And over the same period it saw negative free cash outflow of US$3.9m and booked a US$5.2m accounting loss. While this does make the company a bit risky, it's important to remember it has net cash of US$3.34m. That means it could keep spending at its current rate for more than two years. With very solid revenue growth in the last year, Corero Network Security may be on a path to profitability. By investing before those profits, shareholders take on more risk in the hope of bigger rewards. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should be aware of the 2 warning signs we've spotted with Corero Network Security .
If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.
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. 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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