Is Quorum Information Technologies (CVE:QIS) A Risky Investment?

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. We note that Quorum Information Technologies Inc. (CVE:QIS) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for Quorum Information Technologies

What Is Quorum Information Technologies's Debt?

You can click the graphic below for the historical numbers, but it shows that as of March 2020 Quorum Information Technologies had CA$9.13m of debt, an increase on CA$8.65m, over one year. However, it does have CA$8.47m in cash offsetting this, leading to net debt of about CA$666.6k.

How Strong Is Quorum Information Technologies's Balance Sheet?

The latest balance sheet data shows that Quorum Information Technologies had liabilities of CA$3.80m due within a year, and liabilities of CA$15.7m falling due after that. On the other hand, it had cash of CA$8.47m and CA$3.54m worth of receivables due within a year. So it has liabilities totalling CA$7.5m more than its cash and near-term receivables, combined.

Of course, Quorum Information Technologies has a market capitalization of CA$57.9m, so these liabilities are probably manageable. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. Carrying virtually no net debt, Quorum Information Technologies has a very light debt load indeed.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Quorum Information Technologies's debt of just -50.98 times EBITDA is clearly modest. But strangely, EBIT was only 0.059 times interest expenses, suggesting the that may paint an overly pretty picture of the stock. Notably, Quorum Information Technologies made a loss at the EBIT level, last year, but improved that to positive EBIT of CA$79k in the last twelve months. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Quorum Information Technologies's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it is important to check how much of its earnings before interest and tax (EBIT) converts to actual free cash flow. During the last year, Quorum Information Technologies burned a lot of cash. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Our View

Neither Quorum Information Technologies's ability to convert EBIT to free cash flow nor its interest cover gave us confidence in its ability to take on more debt. But its net debt to EBITDA tells a very different story, and suggests some resilience. When we consider all the factors discussed, it seems to us that Quorum Information Technologies is taking some risks with its use of debt. So while that leverage does boost returns on equity, we wouldn't really want to see it increase from here. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 2 warning signs for Quorum Information Technologies that you should be aware of.

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.

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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.
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