Cokal (ASX:CKA) Is Carrying A Fair Bit Of Debt

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.' 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. Importantly, Cokal Limited (ASX:CKA) does carry debt. But should shareholders be worried about its use of debt?

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. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Cokal

How Much Debt Does Cokal Carry?

You can click the graphic below for the historical numbers, but it shows that Cokal had US$2.08m of debt in June 2020, down from US$11.4m, one year before. On the flip side, it has US$779.7k in cash leading to net debt of about US$1.30m.

How Healthy Is Cokal's Balance Sheet?

According to the last reported balance sheet, Cokal had liabilities of US$17.7m due within 12 months, and liabilities of US$7.7k due beyond 12 months. Offsetting this, it had US$779.7k in cash and US$10.1k in receivables that were due within 12 months. So it has liabilities totalling US$16.9m more than its cash and near-term receivables, combined.

While this might seem like a lot, it is not so bad since Cokal has a market capitalization of US$50.2m, and so it could probably strengthen its balance sheet by raising capital if it needed to. But it's clear that we should definitely closely examine whether it can manage its debt without dilution. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Cokal 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 Cokal wasn't profitable at an EBIT level, but managed to grow its revenue by 83%, to US$9.3m. With any luck the company will be able to grow its way to profitability.

Caveat Emptor

While we can certainly appreciate Cokal's revenue growth, its earnings before interest and tax (EBIT) loss is not ideal. To be specific the EBIT loss came in at US$2.6m. 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 US$2.1m in negative free cash flow over the last twelve months. So to be blunt we think it is 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. Be aware that Cokal is showing 3 warning signs in our investment analysis , and 1 of those doesn't sit too well with us...

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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