Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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. We note that Naked Wines plc (LON:WINE) does have debt on its balance sheet. But should shareholders be worried about its use of debt?
When Is Debt A Problem?
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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.
How Much Debt Does Naked Wines Carry?
The image below, which you can click on for greater detail, shows that at April 2019 Naked Wines had debt of UK£34.6m, up from UK£24.1m in one year. However, it also had UK£19.1m in cash, and so its net debt is UK£15.5m.
How Healthy Is Naked Wines's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Naked Wines had liabilities of UK£129.7m due within 12 months and liabilities of UK£25.4m due beyond that. Offsetting this, it had UK£19.1m in cash and UK£16.5m in receivables that were due within 12 months. So it has liabilities totalling UK£119.5m more than its cash and near-term receivables, combined.
This is a mountain of leverage relative to its market capitalization of UK£192.5m. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Naked Wines'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 Naked Wines managed to grow its revenue by 6.3%, to UK£506m. We usually like to see faster growth from unprofitable companies, but each to their own.
Importantly, Naked Wines had negative earnings before interest and tax (EBIT), over the last year. To be specific the EBIT loss came in at UK£7.7m. 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. Another cause for caution is that is bled UK£1.2m in negative free cash flow over the last twelve months. So suffice it to say we do consider the stock to be risky. 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 Naked Wines 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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