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. 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 Micro-X Limited (ASX:MX1) makes use of debt. But the real question is whether this debt is making the company risky.
What Risk Does Debt Bring?
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. If things get really bad, the lenders can take control of the business. 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. 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 Micro-X's Net Debt?
You can click the graphic below for the historical numbers, but it shows that as of December 2019 Micro-X had AU$7.54m of debt, an increase on AU$6.75m, over one year. However, its balance sheet shows it holds AU$12.4m in cash, so it actually has AU$4.83m net cash.
How Strong Is Micro-X's Balance Sheet?
The latest balance sheet data shows that Micro-X had liabilities of AU$7.66m due within a year, and liabilities of AU$10.3m falling due after that. On the other hand, it had cash of AU$12.4m and AU$2.01m worth of receivables due within a year. So it has liabilities totalling AU$3.56m more than its cash and near-term receivables, combined.
Since publicly traded Micro-X shares are worth a total of AU$27.5m, it seems unlikely that this level of liabilities would be a major threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. Despite its noteworthy liabilities, Micro-X boasts net cash, so it's fair to say it does not have a heavy debt load! The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Micro-X's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.
In the last year Micro-X wasn't profitable at an EBIT level, but managed to grow its revenue by 2.8%, to AU$1.8m. We usually like to see faster growth from unprofitable companies, but each to their own.
So How Risky Is Micro-X?
Statistically speaking companies that lose money are riskier than those that make money. And the fact is that over the last twelve months Micro-X lost money at the earnings before interest and tax (EBIT) line. Indeed, in that time it burnt through AU$9.9m of cash and made a loss of AU$7.6m. But at least it has AU$4.83m on the balance sheet to spend on growth, near-term. 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. To that end, you should be aware of the 5 warning signs we've spotted with Micro-X .
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.
If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. 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. Simply Wall St has no position in the stocks mentioned.
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