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 Comvita Limited (NZSE:CVT) does use debt in its business. But the more important question is: how much risk is that debt creating?
What Risk Does Debt Bring?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.
How Much Debt Does Comvita Carry?
The chart below, which you can click on for greater detail, shows that Comvita had NZ$99.3m in debt in June 2019; about the same as the year before. However, because it has a cash reserve of NZ$10.3m, its net debt is less, at about NZ$88.9m.
How Healthy Is Comvita's Balance Sheet?
We can see from the most recent balance sheet that Comvita had liabilities of NZ$36.7m falling due within a year, and liabilities of NZ$100.6m due beyond that. On the other hand, it had cash of NZ$10.3m and NZ$44.3m worth of receivables due within a year. So it has liabilities totalling NZ$82.6m more than its cash and near-term receivables, combined.
This is a mountain of leverage relative to its market capitalization of NZ$129.3m. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Comvita'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.
In the last year Comvita actually shrunk its revenue by 4.1%, to NZ$171m. That's not what we would hope to see.
Over the last twelve months Comvita produced an earnings before interest and tax (EBIT) loss. Indeed, it lost NZ$7.8m 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. For example, we would not want to see a repeat of last year's loss of-NZ$27.7m. So we do think this stock is quite risky. For riskier companies like Comvita 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.
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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