Here's Why Buddy Technologies (ASX:BUD) Can Afford Some Debt

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. As with many other companies Buddy Technologies Limited (ASX:BUD) makes use of debt. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. 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. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Buddy Technologies

What Is Buddy Technologies's Net Debt?

As you can see below, at the end of June 2021, Buddy Technologies had AU$31.3m of debt, up from AU$14.6m a year ago. Click the image for more detail. However, it also had AU$2.09m in cash, and so its net debt is AU$29.2m.

How Healthy Is Buddy Technologies' Balance Sheet?

According to the last reported balance sheet, Buddy Technologies had liabilities of AU$31.8m due within 12 months, and liabilities of AU$10.2m due beyond 12 months. Offsetting this, it had AU$2.09m in cash and AU$4.98m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by AU$34.9m.

This deficit isn't so bad because Buddy Technologies is worth AU$61.8m, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt. 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 Buddy Technologies 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, Buddy Technologies made a loss at the EBIT level, and saw its revenue drop to AU$29m, which is a fall of 7.2%. That's not what we would hope to see.

Caveat Emptor

Importantly, Buddy Technologies had an earnings before interest and tax (EBIT) loss over the last year. Its EBIT loss was a whopping AU$15m. 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. So we think its balance sheet is a little strained, though not beyond repair. Another cause for caution is that is bled AU$21m in negative free cash flow over the last twelve months. So suffice it to say we consider the stock very risky. 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. For example, we've discovered 5 warning signs for Buddy Technologies (2 are potentially serious!) that you should be aware of before investing here.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
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