The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a 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. As with many other companies ENTREC Corporation (TSE:ENT) makes use of debt. But the real question is whether this debt is making the company risky.
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. If things get really bad, the lenders can take control of the business. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.
What Is ENTREC's Debt?
As you can see below, ENTREC had CA$157.2m of debt, at June 2019, which is about the same the year before. You can click the chart for greater detail. And it doesn't have much cash, so its net debt is about the same.
How Healthy Is ENTREC's Balance Sheet?
The latest balance sheet data shows that ENTREC had liabilities of CA$176.8m due within a year, and liabilities of CA$106.7m falling due after that. On the other hand, it had cash of CA$890.0k and CA$40.3m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by CA$242.3m.
This deficit casts a shadow over the CA$9.34m company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. At the end of the day, ENTREC would probably need a major re-capitalization if its creditors were to demand repayment. There's no doubt that we learn most about debt from the balance sheet. But it is ENTREC'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 ENTREC wasn't profitable at an EBIT level, but managed to grow its revenue by12%, to CA$179m. That rate of growth is a bit slow for our taste, but it takes all types to make a world.
Over the last twelve months ENTREC produced an earnings before interest and tax (EBIT) loss. Its EBIT loss was a whopping CA$2.0m. When you combine this with the very significant balance sheet liabilities mentioned above, we are so wary of it that we are basically at a loss for the right words. Like every long-shot we're sure it has a glossy presentation outlining its blue-sky potential. But the reality is that it is low on liquid assets relative to liabilities, and it lost CA$12m in the last year. So we think buying this stock is risky, like walking through a minefield with a mask on. 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 ENTREC insider transactions.
If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.
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