Does Connected IO (ASX:CIO) 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. We can see that Connected IO Limited (ASX:CIO) does use debt in its business. But is this debt a concern to shareholders?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Connected IO

How Much Debt Does Connected IO Carry?

The image below, which you can click on for greater detail, shows that at June 2020 Connected IO had debt of AU$2.02m, up from AU$1.57m in one year. On the flip side, it has AU$713.1k in cash leading to net debt of about AU$1.31m.

How Healthy Is Connected IO's Balance Sheet?

We can see from the most recent balance sheet that Connected IO had liabilities of AU$2.88m falling due within a year, and liabilities of AU$356.4k due beyond that. Offsetting this, it had AU$713.1k in cash and AU$145.7k in receivables that were due within 12 months. So it has liabilities totalling AU$2.38m more than its cash and near-term receivables, combined.

This deficit isn't so bad because Connected IO is worth AU$4.22m, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Connected IO 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 Connected IO wasn't profitable at an EBIT level, but managed to grow its revenue by 47%, to AU$3.8m. Shareholders probably have their fingers crossed that it can grow its way to profits.

Caveat Emptor

Despite the top line growth, Connected IO still had an earnings before interest and tax (EBIT) loss over the last year. Its EBIT loss was a whopping AU$2.2m. 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 AU$1.4m in negative free cash flow over the last twelve months. So suffice it to say we consider the stock very risky. 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. Be aware that Connected IO is showing 5 warning signs in our investment analysis , and 2 of those can't be ignored...

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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This article by Simply Wall St is general in nature. 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.
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