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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We can see that Compumedics Limited (ASX:CMP) does use debt in its business. But is this debt a concern to shareholders?
When Is Debt A Problem?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. 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. 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. When we think about a company's use of debt, we first look at cash and debt together.
What Is Compumedics's Debt?
You can click the graphic below for the historical numbers, but it shows that as of December 2022 Compumedics had AU$8.05m of debt, an increase on AU$6.87m, over one year. However, it also had AU$5.67m in cash, and so its net debt is AU$2.38m.
How Healthy Is Compumedics' Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Compumedics had liabilities of AU$21.1m due within 12 months and liabilities of AU$1.73m due beyond that. On the other hand, it had cash of AU$5.67m and AU$11.4m worth of receivables due within a year. So its liabilities total AU$5.82m more than the combination of its cash and short-term receivables.
Of course, Compumedics has a market capitalization of AU$30.1m, so these liabilities are probably manageable. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. 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 Compumedics 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 Compumedics wasn't profitable at an EBIT level, but managed to grow its revenue by 17%, to AU$40m. We usually like to see faster growth from unprofitable companies, but each to their own.
Over the last twelve months Compumedics produced an earnings before interest and tax (EBIT) loss. Indeed, it lost a very considerable AU$8.0m 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$2.5m of cash over the last year. So in short it's a really risky stock. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For example Compumedics has 2 warning signs (and 1 which is potentially serious) we think you should know about.
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.
Compumedics Limited engages in the research, development, manufacturing, and distribution of medical equipment and related technologies in Australia, the Asia Pacific, the Americas, Europe, and the Middle East.
Mediocre balance sheet and slightly overvalued.