Is Xebec Adsorption (CVE:XBC) A Risky Investment?

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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 can see that Xebec Adsorption Inc. (CVE:XBC) does use debt in its business. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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.

See our latest analysis for Xebec Adsorption

What Is Xebec Adsorption's Net Debt?

As you can see below, at the end of June 2020, Xebec Adsorption had CA$12.5m of debt, up from CA$3.81m a year ago. Click the image for more detail. However, its balance sheet shows it holds CA$60.0m in cash, so it actually has CA$47.5m net cash.

A Look At Xebec Adsorption's Liabilities

According to the last reported balance sheet, Xebec Adsorption had liabilities of CA$15.7m due within 12 months, and liabilities of CA$17.8m due beyond 12 months. Offsetting this, it had CA$60.0m in cash and CA$28.6m in receivables that were due within 12 months. So it can boast CA$55.1m more liquid assets than total liabilities.

This surplus suggests that Xebec Adsorption has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Xebec Adsorption has more cash than debt is arguably a good indication that it can manage its debt safely.

Shareholders should be aware that Xebec Adsorption's EBIT was down 34% last year. If that earnings trend continues then paying off its debt will be about as easy as herding cats on to a roller coaster. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Xebec Adsorption can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. Xebec Adsorption may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Over the last two years, Xebec Adsorption saw substantial negative free cash flow, in total. 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.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Xebec Adsorption has net cash of CA$47.5m, as well as more liquid assets than liabilities. Despite the cash, we do find Xebec Adsorption's EBIT growth rate concerning, so we're not particularly comfortable with the stock. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. Consider for instance, the ever-present spectre of investment risk. We've identified 2 warning signs with Xebec Adsorption (at least 1 which can't be ignored) , and understanding them should be part of your investment process.

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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