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Is Hot Chili (ASX:HCH) Using Debt In A Risky Way?

Simply Wall St
·4 mins read

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. As with many other companies Hot Chili Limited (ASX:HCH) makes use of debt. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Hot Chili

What Is Hot Chili's Net Debt?

The image below, which you can click on for greater detail, shows that Hot Chili had debt of AU$4.19m at the end of June 2020, a reduction from AU$4.56m over a year. But on the other hand it also has AU$6.31m in cash, leading to a AU$2.12m net cash position.

debt-equity-history-analysis
debt-equity-history-analysis

How Healthy Is Hot Chili's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Hot Chili had liabilities of AU$6.11m due within 12 months and liabilities of AU$4.19m due beyond that. On the other hand, it had cash of AU$6.31m and AU$7.6k worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by AU$3.98m.

Given Hot Chili has a market capitalization of AU$93.7m, it's hard to believe these liabilities pose much threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. Despite its noteworthy liabilities, Hot Chili 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 it is Hot Chili's earnings that will influence how the balance sheet holds up in the future. 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, investors are probably hoping that Hot Chili finds some valuable resources, before it runs out of money.

So How Risky Is Hot Chili?

We have no doubt that loss making companies are, in general, riskier than profitable ones. And we do note that Hot Chili had an earnings before interest and tax (EBIT) loss, over the last year. Indeed, in that time it burnt through AU$20m of cash and made a loss of AU$1.2m. With only AU$2.12m on the balance sheet, it would appear that its going to need to raise capital again soon. Summing up, we're a little skeptical of this one, as it seems fairly risky in the absence of free cashflow. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. Be aware that Hot Chili is showing 5 warning signs in our investment analysis , and 2 of those are a bit concerning...

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.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com.