The external fund manager backed by Berkshire Hathaway’s Charlie Munger, Li Lu, makes no bones about it when he says ‘The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital. When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We note that Caspian Sunrise plc (LON:CASP) does have debt on its balance sheet. But is this debt a concern to shareholders?
Why Does Debt Bring Risk?
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. 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. Having said that, the most common situation is where a company manages its debt reasonably well – and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.
What Is Caspian Sunrise’s Debt?
The image below, which you can click on for greater detail, shows that at June 2019 Caspian Sunrise had debt of US$3.31m, up from US$1.74m in one year. However, because it has a cash reserve of US$1.54m, its net debt is less, at about US$1.78m.
A Look At Caspian Sunrise’s Liabilities
We can see from the most recent balance sheet that Caspian Sunrise had liabilities of US$17.6m falling due within a year, and liabilities of US$18.8m due beyond that. On the other hand, it had cash of US$1.54m and US$242.0k worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$34.6m.
Given Caspian Sunrise has a market capitalization of US$179.7m, it’s hard to believe these liabilities pose much threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. Carrying virtually no net debt, Caspian Sunrise has a very light debt load indeed. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet – far from it. For example, we’ve discovered 4 warning signs for Caspian Sunrise (of which 2 are major) which any shareholder or potential investor should be aware of.
Over 12 months, Caspian Sunrise reported revenue of US$10m, which is a gain of 2.3%, although it did not report any earnings before interest and tax. We usually like to see faster growth from unprofitable companies, but each to their own.
Over the last twelve months Caspian Sunrise produced an earnings before interest and tax (EBIT) loss. Indeed, it lost US$2.7m at the EBIT level. Considering that alongside the liabilities mentioned above does not give us much confidence that company should be using so much 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 US$763k in negative free cash flow over the last twelve months. So suffice it to say we do consider the stock to be risky. When we look at a riskier company, we like to check how their profits (or losses) are trending over time. Today, we’re providing readers this interactive graph showing how Caspian Sunrise’s profit, revenue, and operating cashflow have changed over the last few years.
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.
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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