Is Candy Club Holdings (ASX:CLB) Using Too Much Debt?

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We can see that Candy Club Holdings Limited (ASX:CLB) does use debt in its business. But the real question is whether this debt is making the company risky.

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. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Candy Club Holdings

What Is Candy Club Holdings's Net Debt?

The image below, which you can click on for greater detail, shows that at December 2021 Candy Club Holdings had debt of US$7.34m, up from US$2.80m in one year. However, it does have US$5.20m in cash offsetting this, leading to net debt of about US$2.14m.

How Healthy Is Candy Club Holdings' Balance Sheet?

We can see from the most recent balance sheet that Candy Club Holdings had liabilities of US$4.83m falling due within a year, and liabilities of US$5.41m due beyond that. Offsetting these obligations, it had cash of US$5.20m as well as receivables valued at US$1.76m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$3.27m.

Given Candy Club Holdings has a market capitalization of US$27.6m, it's hard to believe these liabilities pose much threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. There's no doubt that we learn most about debt from the balance sheet. But it is Candy Club Holdings's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

In the last year Candy Club Holdings wasn't profitable at an EBIT level, but managed to grow its revenue by 91%, to US$17m. Shareholders probably have their fingers crossed that it can grow its way to profits.

Caveat Emptor

While we can certainly appreciate Candy Club Holdings's revenue growth, its earnings before interest and tax (EBIT) loss is not ideal. Indeed, it lost a very considerable US$5.1m 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. However, it doesn't help that it burned through US$11m of cash over the last year. So suffice it to say we consider the stock very risky. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. We've identified 4 warning signs with Candy Club Holdings (at least 2 which are concerning) , and understanding them should be part of your investment process.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.