Is Experience Co (ASX:EXP) Using Debt In A Risky Way?

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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. As with many other companies Experience Co Limited (ASX:EXP) makes use of debt. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Experience Co

How Much Debt Does Experience Co Carry?

As you can see below, Experience Co had AU$7.84m of debt at December 2021, down from AU$8.66m a year prior. But on the other hand it also has AU$27.5m in cash, leading to a AU$19.7m net cash position.

A Look At Experience Co's Liabilities

We can see from the most recent balance sheet that Experience Co had liabilities of AU$34.1m falling due within a year, and liabilities of AU$30.7m due beyond that. Offsetting this, it had AU$27.5m in cash and AU$2.12m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by AU$35.1m.

This deficit isn't so bad because Experience Co is worth AU$158.0m, and thus could probably raise enough capital to shore up 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. While it does have liabilities worth noting, Experience Co also has more cash than debt, so we're pretty confident it can manage its debt safely. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Experience Co's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Over 12 months, Experience Co made a loss at the EBIT level, and saw its revenue drop to AU$44m, which is a fall of 8.0%. That's not what we would hope to see.

So How Risky Is Experience Co?

Statistically speaking companies that lose money are riskier than those that make money. And the fact is that over the last twelve months Experience Co lost money at the earnings before interest and tax (EBIT) line. Indeed, in that time it burnt through AU$8.9m of cash and made a loss of AU$8.2m. Given it only has net cash of AU$19.7m, the company may need to raise more capital if it doesn't reach break-even soon. Overall, we'd say the stock is a bit risky, and we're usually very cautious until we see positive free cash flow. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 2 warning signs for Experience Co 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.