David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' 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. We can see that Zentek Ltd. (CVE:ZEN) does use debt in its business. But is this debt a concern to shareholders?
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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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 step when considering a company's debt levels is to consider its cash and debt together.
What Is Zentek's Net Debt?
You can click the graphic below for the historical numbers, but it shows that as of March 2022 Zentek had CA$1.95m of debt, an increase on none, over one year. However, it does have CA$26.7m in cash offsetting this, leading to net cash of CA$24.7m.
How Strong Is Zentek's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Zentek had liabilities of CA$2.30m due within 12 months and liabilities of CA$1.13m due beyond that. On the other hand, it had cash of CA$26.7m and CA$3.61m worth of receivables due within a year. So it actually has CA$26.8m more liquid assets than total liabilities.
This short term liquidity is a sign that Zentek could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that Zentek has more cash than debt is arguably a good indication that it can manage its debt safely. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Zentek'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.
Given its lack of meaningful operating revenue, Zentek shareholders no doubt hope it can fund itself until it can sell some of its new medical technology.
So How Risky Is Zentek?
Statistically speaking companies that lose money are riskier than those that make money. And the fact is that over the last twelve months Zentek lost money at the earnings before interest and tax (EBIT) line. Indeed, in that time it burnt through CA$12m of cash and made a loss of CA$12m. Given it only has net cash of CA$24.7m, the company may need to raise more capital if it doesn't reach break-even soon. The good news for shareholders is that Zentek has dazzling revenue growth, so there's a very good chance it can boost its free cash flow in the years to come. While unprofitable companies can be risky, they can also grow hard and fast in those pre-profit years. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. For example Zentek has 4 warning signs (and 2 which are a bit unpleasant) we think you should know about.
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.
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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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.