Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a 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. As with many other companies Seafarms Group Limited (ASX:SFG) makes use of debt. But should shareholders be worried about its use of debt?
When Is Debt Dangerous?
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. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.
See our latest analysis for Seafarms Group
What Is Seafarms Group's Debt?
As you can see below, at the end of December 2020, Seafarms Group had AU$21.3m of debt, up from AU$14.1m a year ago. Click the image for more detail. However, it does have AU$5.52m in cash offsetting this, leading to net debt of about AU$15.8m.
How Healthy Is Seafarms Group's Balance Sheet?
The latest balance sheet data shows that Seafarms Group had liabilities of AU$21.4m due within a year, and liabilities of AU$28.9m falling due after that. On the other hand, it had cash of AU$5.52m and AU$5.54m worth of receivables due within a year. So its liabilities total AU$39.2m more than the combination of its cash and short-term receivables.
Since publicly traded Seafarms Group shares are worth a total of AU$225.3m, it seems unlikely that this level of liabilities would be a major threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Seafarms Group 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.
In the last year Seafarms Group had a loss before interest and tax, and actually shrunk its revenue by 21%, to AU$22m. That makes us nervous, to say the least.
Caveat Emptor
While Seafarms Group's falling revenue is about as heartwarming as a wet blanket, arguably its earnings before interest and tax (EBIT) loss is even less appealing. Indeed, it lost AU$19m 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. So we think its balance sheet is a little strained, though not beyond repair. However, it doesn't help that it burned through AU$13m of cash over the last year. 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. Case in point: We've spotted 3 warning signs for Seafarms Group you should be aware of, and 2 of them make us uncomfortable.
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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About ASX:SFG
Seafarms Group
Operates as an aquaculture company in Australia and internationally.
Adequate balance sheet low.