Warren Buffett famously said, 'Volatility is far from synonymous with risk.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. As with many other companies CounterPath Corporation (TSE:PATH) makes use of debt. But the more important question is: how much risk is that debt creating?
Why Does Debt Bring Risk?
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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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.
What Is CounterPath's Debt?
As you can see below, at the end of April 2019, CounterPath had US$3.00m of debt, up from none a year ago. Click the image for more detail. However, it does have US$1.86m in cash offsetting this, leading to net debt of about US$1.14m.
How Healthy Is CounterPath's Balance Sheet?
The latest balance sheet data shows that CounterPath had liabilities of US$4.89m due within a year, and liabilities of US$3.01m falling due after that. Offsetting these obligations, it had cash of US$1.86m as well as receivables valued at US$1.88m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$4.16m.
CounterPath has a market capitalization of US$7.38m, 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. The balance sheet is clearly the area to focus on when you are analysing debt. But it is CounterPath'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.
In the last year CounterPath actually shrunk its revenue by 13%, to US$11m. That's not what we would hope to see.
While CounterPath'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 US$5.3m 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 US$3.5m in negative free cash flow over the last twelve months. So suffice it to say we consider the stock very risky. For riskier companies like CounterPath I always like to keep an eye on the long term profit and revenue trends. Fortunately, you can click to see our interactive graph of its profit, revenue, and operating cashflow.
At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.
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