Is Hot Chili (ASX:HCH) Using Debt In A Risky Way?

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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. As with many other companies Hot Chili Limited (ASX:HCH) makes use of debt. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. If things get really bad, the lenders can take control of the business. 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.

View our latest analysis for Hot Chili

How Much Debt Does Hot Chili Carry?

You can click the graphic below for the historical numbers, but it shows that as of December 2021 Hot Chili had AU$5.82m of debt, an increase on AU$4.69m, over one year. But on the other hand it also has AU$37.2m in cash, leading to a AU$31.4m net cash position.

How Strong Is Hot Chili's Balance Sheet?

According to the balance sheet data, Hot Chili had liabilities of AU$15.5m due within 12 months, but no longer term liabilities. On the other hand, it had cash of AU$37.2m and AU$14.8k worth of receivables due within a year. So it actually has AU$21.7m more liquid assets than total liabilities.

It's good to see that Hot Chili has plenty of liquidity on its balance sheet, suggesting conservative management of liabilities. Because it has plenty of assets, it is unlikely to have trouble with its lenders. Succinctly put, Hot Chili boasts net cash, so it's fair to say it does not have a heavy debt load! When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Hot Chili can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Given its lack of meaningful operating revenue, investors are probably hoping that Hot Chili finds some valuable resources, before it runs out of money.

So How Risky Is Hot Chili?

We have no doubt that loss making companies are, in general, riskier than profitable ones. And in the last year Hot Chili had an earnings before interest and tax (EBIT) loss, truth be told. And over the same period it saw negative free cash outflow of AU$38m and booked a AU$6.6m accounting loss. Given it only has net cash of AU$31.4m, the company may need to raise more capital if it doesn't reach break-even soon. Even though its balance sheet seems sufficiently liquid, debt always makes us a little nervous if a company doesn't produce free cash flow regularly. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. We've identified 7 warning signs with Hot Chili (at least 3 which are a bit unpleasant) , and understanding them should be part of your investment process.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.