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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. Importantly, Verde Agritech Plc (TSE:NPK) does carry debt. But should shareholders be worried about its use of debt?
When Is Debt A Problem?
Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. 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. 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 think about a company's use of debt, we first look at cash and debt together.
What Is Verde Agritech's Debt?
As you can see below, at the end of June 2019, Verde Agritech had CA$405.0k of debt, up from none a year ago. Click the image for more detail. However, it does have CA$1.02m in cash offsetting this, leading to net cash of CA$617.0k.
How Strong Is Verde Agritech's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Verde Agritech had liabilities of CA$1.43m due within 12 months and liabilities of CA$6.47m due beyond that. Offsetting this, it had CA$1.02m in cash and CA$1.49m in receivables that were due within 12 months. So its liabilities total CA$5.39m more than the combination of its cash and short-term receivables.
Since publicly traded Verde Agritech shares are worth a total of CA$33.1m, 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, Verde Agritech boasts net cash, so it's fair to say it does not have a heavy debt load! There's no doubt that we learn most about debt from the balance sheet. But it is Verde Agritech'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 Verde Agritech managed to produce its first revenue as a listed company, but given the lack of profit, shareholders will no doubt be hoping to see some strong increases.
So How Risky Is Verde Agritech?
We have no doubt that loss making companies are, in general, riskier than profitable ones. And in the last year Verde Agritech had negative earnings before interest and tax (EBIT), truth be told. Indeed, in that time it burnt through CA$2.3m of cash and made a loss of CA$2.0m. Given it only has net cash of CA$1.0m, the company may need to raise more capital if it doesn't reach break-even soon. Summing up, we're a little skeptical of this one, as it seems fairly risky in the absence of free cashflow. For riskier companies like Verde Agritech I always like to keep an eye on whether insiders are buying or selling. So click here if you want to find out for yourself.
When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.
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