Is Eden Innovations (ASX:EDE) Using Too Much 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.' 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 Eden Innovations Ltd (ASX:EDE) makes use of debt. But is this debt a concern to shareholders?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Eden Innovations

How Much Debt Does Eden Innovations Carry?

You can click the graphic below for the historical numbers, but it shows that as of June 2023 Eden Innovations had AU$10.2m of debt, an increase on AU$4.91m, over one year. However, it also had AU$2.53m in cash, and so its net debt is AU$7.67m.

How Healthy Is Eden Innovations' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Eden Innovations had liabilities of AU$12.1m due within 12 months and liabilities of AU$130.1k due beyond that. On the other hand, it had cash of AU$2.53m and AU$275.7k worth of receivables due within a year. So its liabilities total AU$9.47m more than the combination of its cash and short-term receivables.

This deficit is considerable relative to its market capitalization of AU$10.5m, so it does suggest shareholders should keep an eye on Eden Innovations' use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution. 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 Eden Innovations 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, Eden Innovations reported revenue of AU$4.8m, which is a gain of 14%, although it did not report any earnings before interest and tax. That rate of growth is a bit slow for our taste, but it takes all types to make a world.

Caveat Emptor

Over the last twelve months Eden Innovations produced an earnings before interest and tax (EBIT) loss. Its EBIT loss was a whopping AU$6.0m. 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. Another cause for caution is that is bled AU$5.2m 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. But ultimately, every company can contain risks that exist outside of the balance sheet. We've identified 6 warning signs with Eden Innovations (at least 4 which make us uncomfortable) , and understanding them should be part of your investment process.

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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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.