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Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about. 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. Importantly, Isodiol International Inc. (CNSX:ISOL) does carry debt. But should shareholders be worried about its use of debt?
When Is Debt Dangerous?
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. 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, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
What Is Isodiol International's Net Debt?
As you can see below, at the end of June 2019, Isodiol International had CA$5.28m of debt, up from CA$445.9k a year ago. Click the image for more detail. However, because it has a cash reserve of CA$4.44m, its net debt is less, at about CA$842.2k.
How Healthy Is Isodiol International's Balance Sheet?
According to the last reported balance sheet, Isodiol International had liabilities of CA$8.36m due within 12 months, and liabilities of CA$5.74m due beyond 12 months. Offsetting these obligations, it had cash of CA$4.44m as well as receivables valued at CA$5.00m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CA$4.65m.
Isodiol International has a market capitalization of CA$11.6m, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Isodiol International 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.
In the last year Isodiol International had negative earnings before interest and tax, and actually shrunk its revenue by 10%, to CA$20m. We would much prefer see growth.
Not only did Isodiol International's revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). Indeed, it lost a very considerable CA$38m at the EBIT level. Considering that alongside the liabilities mentioned above does not give us much confidence that company should be using so much debt. So we think its balance sheet is a little strained, though not beyond repair. We would feel better if it turned its trailing twelve month loss of CA$120m into a profit. So in short it's a really risky stock. When I consider a company to be a bit risky, I think it is responsible to check out whether insiders have been reporting any share sales. Luckily, you can click here ito see our graphic depicting Isodiol International insider transactions.
If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.
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