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 seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. Importantly, Cyanotech Corporation (NASDAQ:CYAN) does carry debt. But the real question is whether this debt is making the company risky.
What Risk Does Debt Bring?
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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. 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.
What Is Cyanotech's Debt?
The image below, which you can click on for greater detail, shows that at June 2019 Cyanotech had debt of US$9.28m, up from US$7.55m in one year. On the flip side, it has US$1.06m in cash leading to net debt of about US$8.22m.
How Strong Is Cyanotech's Balance Sheet?
The latest balance sheet data shows that Cyanotech had liabilities of US$8.08m due within a year, and liabilities of US$10.3m falling due after that. Offsetting these obligations, it had cash of US$1.06m as well as receivables valued at US$1.79m due within 12 months. So its liabilities total US$15.6m more than the combination of its cash and short-term receivables.
Given this deficit is actually higher than the company's market capitalization of US$14.8m, we think shareholders really should watch Cyanotech's debt levels, like a parent watching their child ride a bike for the first time. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer extensive dilution. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Cyanotech will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.
Over 12 months, Cyanotech saw its revenue drop to US$31m, which is a fall of 4.1%. That's not what we would hope to see.
Over the last twelve months Cyanotech produced an earnings before interest and tax (EBIT) loss. To be specific the EBIT loss came in at US$1.0m. When we look at that alongside the significant liabilities, we're not particularly confident about the company. It would need to improve its operations quickly for us to be interested in it. Not least because it burned through US$1.2m in negative free cash flow over the last year. So suffice it to say we consider the stock to be risky. When we look at a riskier company, we like to check how their profits (or losses) are trending over time. Today, we're providing readers this interactive graph showing how Cyanotech's profit, revenue, and operating cashflow have changed over the last few years.
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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