Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. Importantly, Health and Plant Protein Group Limited (ASX:HPP) does carry debt. But the real question is whether this debt is making the company risky.
What Risk Does Debt Bring?
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. If things get really bad, the lenders can take control of the business. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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.
What Is Health and Plant Protein Group's Net Debt?
As you can see below, Health and Plant Protein Group had AU$22.5m of debt at December 2020, down from AU$23.7m a year prior. However, because it has a cash reserve of AU$10.0m, its net debt is less, at about AU$12.5m.
A Look At Health and Plant Protein Group's Liabilities
We can see from the most recent balance sheet that Health and Plant Protein Group had liabilities of AU$22.7m falling due within a year, and liabilities of AU$11.4m due beyond that. On the other hand, it had cash of AU$10.0m and AU$2.59m worth of receivables due within a year. So its liabilities total AU$21.6m more than the combination of its cash and short-term receivables.
This is a mountain of leverage relative to its market capitalization of AU$29.9m. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry. There's no doubt that we learn most about debt from the balance sheet. But it is Health and Plant Protein Group'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.
In the last year Health and Plant Protein Group wasn't profitable at an EBIT level, but managed to grow its revenue by 20%, to AU$37m. With any luck the company will be able to grow its way to profitability.
Even though Health and Plant Protein Group managed to grow its top line quite deftly, the cold hard truth is that it is losing money on the EBIT line. Indeed, it lost AU$1.5m at the EBIT level. When we look at that and recall the liabilities on its balance sheet, relative to cash, it seems unwise to us for the company to have any debt. So we think its balance sheet is a little strained, though not beyond repair. Another cause for caution is that is bled AU$4.8m in negative free cash flow over the last twelve months. So in short it's a really risky stock. 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. For example - Health and Plant Protein Group has 3 warning signs we think 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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