Is Memphasys (ASX:MEM) A Risky Investment?

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.' 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, Memphasys Limited (ASX:MEM) does carry debt. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Memphasys

How Much Debt Does Memphasys Carry?

You can click the graphic below for the historical numbers, but it shows that as of December 2021 Memphasys had AU$3.62m of debt, an increase on AU$490.3k, over one year. However, it does have AU$1.95m in cash offsetting this, leading to net debt of about AU$1.67m.

How Strong Is Memphasys' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Memphasys had liabilities of AU$4.07m due within 12 months and liabilities of AU$2.07m due beyond that. Offsetting this, it had AU$1.95m in cash and AU$13.6k in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by AU$4.17m.

Since publicly traded Memphasys shares are worth a total of AU$47.5m, it seems unlikely that this level of liabilities would be a major threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. When analysing debt levels, the balance sheet is the obvious place to start. But it is Memphasys's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

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

Caveat Emptor

Importantly, Memphasys had an earnings before interest and tax (EBIT) loss over the last year. To be specific the EBIT loss came in at AU$1.6m. When we look at that and recall the liabilities on its balance sheet, relative to cash, it seems unwise to us for the company to have any 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$3.2m 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. We've identified 5 warning signs with Memphasys (at least 1 which is a bit concerning) , 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.