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. We note that Thermal Energy International Inc. (CVE:TMG) does have debt on its balance sheet. But should shareholders be worried about its use of debt?
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. Part and parcel of capitalism is the process of ‘creative destruction’ where failed businesses are mercilessly liquidated by their bankers. 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 Thermal Energy International’s Net Debt?
The image below, which you can click on for greater detail, shows that at May 2019 Thermal Energy International had debt of CA$3.01m, up from none in one year. However, its balance sheet shows it holds CA$4.18m in cash, so it actually has CA$1.17m net cash.
A Look At Thermal Energy International’s Liabilities
Zooming in on the latest balance sheet data, we can see that Thermal Energy International had liabilities of CA$5.96m due within 12 months and liabilities of CA$3.19m due beyond that. On the other hand, it had cash of CA$4.18m and CA$2.85m worth of receivables due within a year. So it has liabilities totalling CA$2.12m more than its cash and near-term receivables, combined.
Thermal Energy International has a market capitalization of CA$9.71m, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. Despite its noteworthy liabilities, Thermal Energy International boasts net cash, so it’s fair to say it does not have a heavy debt load! When analysing debt levels, the balance sheet is the obvious place to start. But you can’t view debt in total isolation; since Thermal Energy International will need earnings to service that debt. So when considering debt, it’s definitely worth looking at the earnings trend. Click here for an interactive snapshot.
Over 12 months, Thermal Energy International reported revenue of CA$21m, which is a gain of 21%, although it did not report any earnings before interest and tax. Shareholders probably have their fingers crossed that it can grow its way to profits.
So How Risky Is Thermal Energy International?
Although Thermal Energy International had negative earnings before interest and tax (EBIT) over the last twelve months, it generated positive free cash flow of CA$497k. So taking that on face value, and considering the net cash situation, we don’t think that the stock is too risky in the near term. One positive is that Thermal Energy International is growing revenue apace, which makes it easier to sell a growth story and raise capital if need be. But that doesn’t change our opinion that the stock is 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 Thermal Energy International 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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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. Thank you for reading.