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. 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. As with many other companies Fitzroy River Corporation Limited (ASX:FZR) makes use of debt. But should shareholders be worried about its use of debt?
When Is Debt A Problem?
Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. When we think about a company's use of debt, we first look at cash and debt together.
What Is Fitzroy River's Debt?
You can click the graphic below for the historical numbers, but it shows that as of December 2019 Fitzroy River had AU$5.02m of debt, an increase on none, over one year. But on the other hand it also has AU$8.36m in cash, leading to a AU$3.34m net cash position.
How Healthy Is Fitzroy River's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Fitzroy River had liabilities of AU$11.7m due within 12 months and no liabilities due beyond that. Offsetting this, it had AU$8.36m in cash and AU$303.0k in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by AU$3.09m.
Given Fitzroy River has a market capitalization of AU$15.5m, it's hard to believe these liabilities pose much threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. Despite its noteworthy liabilities, Fitzroy River boasts net cash, so it's fair to say it does not have a heavy debt load! When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Fitzroy River will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.
Given its lack of meaningful operating revenue, Fitzroy River shareholders no doubt hope it can fund itself until it can sell some combustibles.
So How Risky Is Fitzroy River?
We have no doubt that loss making companies are, in general, riskier than profitable ones. And in the last year Fitzroy River had negative earnings before interest and tax (EBIT), truth be told. Indeed, in that time it burnt through AU$223k of cash and made a loss of AU$2.4m. But the saving grace is the AU$3.34m on the balance sheet. That means it could keep spending at its current rate for more than two years. Summing up, we're a little skeptical of this one, as it seems fairly risky in the absence of free cashflow. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. Like risks, for instance. Every company has them, and we've spotted 4 warning signs for Fitzroy River (of which 3 make us uncomfortable!) you should know about.
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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This article by Simply Wall St is general in nature. 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. Thank you for reading.