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. Importantly, Novonix Limited (ASX:NVX) does carry 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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
What Is Novonix's Debt?
As you can see below, Novonix had AU$2.21m of debt at June 2020, down from AU$17.2m a year prior. However, it does have AU$38.8m in cash offsetting this, leading to net cash of AU$36.6m.
How Strong Is Novonix's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Novonix had liabilities of AU$4.01m due within 12 months and liabilities of AU$4.72m due beyond that. Offsetting this, it had AU$38.8m in cash and AU$1.23m in receivables that were due within 12 months. So it actually has AU$31.3m more liquid assets than total liabilities.
This short term liquidity is a sign that Novonix could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, Novonix boasts net cash, so it's fair to say it does not have a heavy debt load! 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 Novonix 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, Novonix reported revenue of AU$4.3m, which is a gain of 133%, although it did not report any earnings before interest and tax. So its pretty obvious shareholders are hoping for more growth!
So How Risky Is Novonix?
By their very nature companies that are losing money are more risky than those with a long history of profitability. And we do note that Novonix had an earnings before interest and tax (EBIT) loss, over the last year. Indeed, in that time it burnt through AU$11m of cash and made a loss of AU$20m. With only AU$36.6m on the balance sheet, it would appear that its going to need to raise capital again soon. The good news for shareholders is that Novonix has dazzling revenue growth, so there's a very good chance it can boost its free cash flow in the years to come. High growth pre-profit companies may well be risky, but they can also offer great rewards. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. For instance, we've identified 4 warning signs for Novonix (2 shouldn't be ignored) you should be aware of.
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. 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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