David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' 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 note that Fitzroy River Corporation Limited (ASX:FZR) does have debt on its balance sheet. 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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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. When we examine debt levels, we first consider both cash and debt levels, together.
What Is Fitzroy River's Debt?
You can click the graphic below for the historical numbers, but it shows that as of June 2020 Fitzroy River had AU$3.50m of debt, an increase on none, over one year. However, because it has a cash reserve of AU$624.0k, its net debt is less, at about AU$2.88m.
How Healthy Is Fitzroy River's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Fitzroy River had liabilities of AU$210.0k due within 12 months and liabilities of AU$3.50m due beyond that. On the other hand, it had cash of AU$624.0k and AU$181.0k worth of receivables due within a year. So its liabilities total AU$2.91m more than the combination of its cash and short-term receivables.
While this might seem like a lot, it is not so bad since Fitzroy River has a market capitalization of AU$10.4m, and so it could probably strengthen its balance sheet by raising capital if it needed to. However, it is still worthwhile taking a close look at its ability to pay off debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is Fitzroy River's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.
Given its lack of meaningful operating revenue, Fitzroy River shareholders no doubt hope it can fund itself until it can sell some combustibles.
Over the last twelve months Fitzroy River produced an earnings before interest and tax (EBIT) loss. Indeed, it lost AU$599k 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. Another cause for caution is that is bled AU$529k in negative free cash flow over the last twelve months. So suffice it to say we consider the stock very risky. 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. Case in point: We've spotted 4 warning signs for Fitzroy River you should be aware of.
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. 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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