Happy Valley Nutrition (ASX:HVM) Has Debt But No Earnings; Should You Worry?

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. Importantly, Happy Valley Nutrition Limited (ASX:HVM) does carry debt. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Happy Valley Nutrition

What Is Happy Valley Nutrition's Debt?

The image below, which you can click on for greater detail, shows that at June 2022 Happy Valley Nutrition had debt of NZ$19.6m, up from NZ$16.1m in one year. On the flip side, it has NZ$1.95m in cash leading to net debt of about NZ$17.7m.

How Strong Is Happy Valley Nutrition's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Happy Valley Nutrition had liabilities of NZ$9.91m due within 12 months and liabilities of NZ$9.99m due beyond that. On the other hand, it had cash of NZ$1.95m and NZ$20.3k worth of receivables due within a year. So its liabilities total NZ$17.9m more than the combination of its cash and short-term receivables.

Given this deficit is actually higher than the company's market capitalization of NZ$16.4m, we think shareholders really should watch Happy Valley Nutrition's debt levels, like a parent watching their child ride a bike for the first time. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price. 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 Happy Valley Nutrition will need earnings to service that debt. 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.

It seems likely shareholders hope that Happy Valley Nutrition can significantly advance the business plan before too long, because it doesn't have any significant revenue at the moment.

Caveat Emptor

Over the last twelve months Happy Valley Nutrition produced an earnings before interest and tax (EBIT) loss. Indeed, it lost a very considerable NZ$2.8m at the EBIT level. Considering that alongside the liabilities mentioned above make us nervous about the company. We'd want to see some strong near-term improvements before getting too interested in the stock. Not least because it had negative free cash flow of NZ$4.6m over the last twelve months. So suffice it to say we consider the stock to be 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. For example, we've discovered 5 warning signs for Happy Valley Nutrition (4 are concerning!) 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.