Is Experience Co (ASX:EXP) Using Debt Sensibly?

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

What Risk Does Debt Bring?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. If things get really bad, the lenders can take control of the business. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for Experience Co

How Much Debt Does Experience Co Carry?

As you can see below, Experience Co had AU$9.76m of debt at June 2020, down from AU$20.0m a year prior. However, its balance sheet shows it holds AU$12.5m in cash, so it actually has AU$2.71m net cash.

How Strong Is Experience Co's Balance Sheet?

We can see from the most recent balance sheet that Experience Co had liabilities of AU$14.7m falling due within a year, and liabilities of AU$29.4m due beyond that. Offsetting this, it had AU$12.5m in cash and AU$2.94m in receivables that were due within 12 months. So its liabilities total AU$28.6m more than the combination of its cash and short-term receivables.

Experience Co has a market capitalization of AU$133.4m, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt. 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. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Experience Co can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Over 12 months, Experience Co made a loss at the EBIT level, and saw its revenue drop to AU$87m, which is a fall of 33%. That makes us nervous, to say the least.

So How Risky Is Experience Co?

We have no doubt that loss making companies are, in general, riskier than profitable ones. And we do note that Experience Co had an earnings before interest and tax (EBIT) loss, over the last year. And over the same period it saw negative free cash outflow of AU$1.1m and booked a AU$40m accounting loss. With only AU$2.71m on the balance sheet, it would appear that its going to need to raise capital again soon. Summing up, we're a little skeptical of this one, as it seems fairly risky in the absence of free cashflow. When I consider a company to be a bit risky, I think it is responsible to check out whether insiders have been reporting any share sales. Luckily, you can click here ito see our graphic depicting Experience Co insider transactions.

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.

When trading Experience Co or any other investment, use the platform considered by many to be the Professional's Gateway to the Worlds Market, Interactive Brokers. You get the lowest-cost* trading on stocks, options, futures, forex, bonds and funds worldwide from a single integrated account. Promoted

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. 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.
^*Interactive Brokers Rated Lowest Cost Broker by StockBrokers.com Annual Online Review 2020

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.