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.' 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 Multistack International Limited (ASX:MSI) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?
When Is Debt A Problem?
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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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 think about a company's use of debt, we first look at cash and debt together.
What Is Multistack International's Debt?
The image below, which you can click on for greater detail, shows that at December 2020 Multistack International had debt of AU$2.29m, up from none in one year. However, it does have AU$1.01m in cash offsetting this, leading to net debt of about AU$1.28m.
How Strong Is Multistack International's Balance Sheet?
The latest balance sheet data shows that Multistack International had liabilities of AU$1.95m due within a year, and liabilities of AU$2.34m falling due after that. Offsetting these obligations, it had cash of AU$1.01m as well as receivables valued at AU$233.8k due within 12 months. So it has liabilities totalling AU$3.04m more than its cash and near-term receivables, combined.
Multistack International has a market capitalization of AU$6.06m, 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. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Multistack International's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.
In the last year Multistack International wasn't profitable at an EBIT level, but managed to grow its revenue by 7.3%, to AU$601k. We usually like to see faster growth from unprofitable companies, but each to their own.
Importantly, Multistack International had an earnings before interest and tax (EBIT) loss over the last year. Its EBIT loss was a whopping AU$1.2m. Considering that alongside the liabilities mentioned above does not give us much confidence that company should be using so much debt. So we think its balance sheet is a little strained, though not beyond repair. However, it doesn't help that it burned through AU$2.9m of cash over the last year. So in short it's a really risky stock. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 5 warning signs for Multistack International you should be aware of, and 3 of them are potentially serious.
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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