Does City Chic Collective (ASX:CCX) Have A Healthy Balance Sheet?

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says '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, City Chic Collective Limited (ASX:CCX) does carry debt. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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.

See our latest analysis for City Chic Collective

How Much Debt Does City Chic Collective Carry?

As you can see below, City Chic Collective had AU$12.5m of debt at December 2023, down from AU$35.5m a year prior. However, it does have AU$16.0m in cash offsetting this, leading to net cash of AU$3.54m.

How Strong Is City Chic Collective's Balance Sheet?

According to the last reported balance sheet, City Chic Collective had liabilities of AU$71.2m due within 12 months, and liabilities of AU$37.4m due beyond 12 months. On the other hand, it had cash of AU$16.0m and AU$9.63m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by AU$83.0m.

Given this deficit is actually higher than the company's market capitalization of AU$74.2m, we think shareholders really should watch City Chic Collective's debt levels, like a parent watching their child ride a bike for the first time. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price. Given that City Chic Collective has more cash than debt, we're pretty confident it can handle its debt, despite the fact that it has a lot of liabilities in total. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if City Chic Collective can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Over 12 months, City Chic Collective made a loss at the EBIT level, and saw its revenue drop to AU$225m, which is a fall of 23%. That makes us nervous, to say the least.

So How Risky Is City Chic Collective?

While City Chic Collective lost money on an earnings before interest and tax (EBIT) level, it actually generated positive free cash flow AU$15m. So taking that on face value, and considering the net cash situation, we don't think that the stock is too risky in the near term. Given the lack of transparency around future revenue (and cashflow), we're nervous about this one, until it makes its first big sales. To us, it is a high risk play. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. For example, we've discovered 1 warning sign for City Chic Collective that you should be aware of before investing here.

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.