Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that ‘Volatility is far from synonymous with risk.’ 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 can see that Organto Foods Inc. (CVE:OGO) does use debt in its business. 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. If things get really bad, the lenders can take control of the business. 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. When we examine debt levels, we first consider both cash and debt levels, together.
What Is Organto Foods’s Net Debt?
As you can see below, Organto Foods had CA$1.48m of debt at March 2019, down from CA$3.37m a year prior. However, it does have CA$53.0k in cash offsetting this, leading to net debt of about CA$1.43m.
A Look At Organto Foods’s Liabilities
Zooming in on the latest balance sheet data, we can see that Organto Foods had liabilities of CA$4.34m due within 12 months and no liabilities due beyond that. Offsetting these obligations, it had cash of CA$53.0k as well as receivables valued at CA$765.8k due within 12 months. So it has liabilities totalling CA$3.52m more than its cash and near-term receivables, combined.
While this might seem like a lot, it is not so bad since Organto Foods has a market capitalization of CA$6.82m, and so it could probably strengthen its balance sheet by raising capital if it needed to. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. The balance sheet is clearly the area to focus on when you are analysing debt. But you can’t view debt in total isolation; since Organto Foods 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.
In the last year Organto Foods managed to grow its revenue by 190%, to CA$1.7m. So there’s no doubt that shareholders are cheering for growth
Even though Organto Foods managed to grow its top line quite deftly, the cold hard truth is that it is losing money on the EBIT line. Its EBIT loss was a whopping CA$3.4m. When we look at that and recall the liabilities on its balance sheet, relative to cash, it seems unwise to us for the company to have any debt. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. Another cause for caution is that is bled CA$3.3m in negative free cash flow over the last twelve months. So suffice it to say we consider the stock very risky. For riskier companies like Organto Foods 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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