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 Cathedral Energy Services Ltd. (TSE:CET) makes use of debt. But is this debt a concern to shareholders?
When Is Debt Dangerous?
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 usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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. The first step when considering a company’s debt levels is to consider its cash and debt together.
What Is Cathedral Energy Services’s Debt?
The chart below, which you can click on for greater detail, shows that Cathedral Energy Services had CA$7.00m in debt in September 2019; about the same as the year before. However, it also had CA$6.35m in cash, and so its net debt is CA$652.0k.
A Look At Cathedral Energy Services’s Liabilities
We can see from the most recent balance sheet that Cathedral Energy Services had liabilities of CA$21.6m falling due within a year, and liabilities of CA$26.0m due beyond that. On the other hand, it had cash of CA$6.35m and CA$27.0m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by CA$14.3m.
When you consider that this deficiency exceeds the company’s CA$12.4m market capitalization, you might well be inclined to review the balance sheet intently. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer extensive dilution. There’s no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet – far from it. For example, we’ve discovered 4 warning signs for Cathedral Energy Services (of which 2 are major) which any shareholder or potential investor should be aware of.
In the last year Cathedral Energy Services had negative earnings before interest and tax, and actually shrunk its revenue by 7.7%, to CA$144m. We would much prefer see growth.
Importantly, Cathedral Energy Services had negative earnings before interest and tax (EBIT), over the last year. Its EBIT loss was a whopping CA$22m. Considering that alongside the liabilities mentioned above make us nervous about the company. It would need to improve its operations quickly for us to be interested in it. Not least because it burned through CA$2.6m in negative free cash flow over the last year. That means it’s on the risky side of things. 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 Cathedral Energy Services insider transactions.
Of course, if you’re the type of investor who prefers buying stocks without the burden of debt, then don’t hesitate to discover our exclusive list of net cash growth stocks, today.
If you spot an error that warrants correction, please contact the editor at email@example.com. 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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