Is Comms Group (ASX:CCG) Using Too Much Debt?

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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. As with many other companies Comms Group Limited (ASX:CCG) makes use of debt. But the real question is whether this debt is making the company risky.

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. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Our analysis indicates that CCG is potentially overvalued!

What Is Comms Group's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of June 2022 Comms Group had AU$8.12m of debt, an increase on none, over one year. On the flip side, it has AU$2.94m in cash leading to net debt of about AU$5.18m.

How Healthy Is Comms Group's Balance Sheet?

According to the last reported balance sheet, Comms Group had liabilities of AU$14.2m due within 12 months, and liabilities of AU$17.2m due beyond 12 months. On the other hand, it had cash of AU$2.94m and AU$5.03m worth of receivables due within a year. So its liabilities total AU$23.5m more than the combination of its cash and short-term receivables.

This deficit is considerable relative to its market capitalization of AU$30.0m, so it does suggest shareholders should keep an eye on Comms Group's use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Comms Group will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

In the last year Comms Group wasn't profitable at an EBIT level, but managed to grow its revenue by 64%, to AU$41m. With any luck the company will be able to grow its way to profitability.

Caveat Emptor

Even though Comms Group managed to grow its top line quite deftly, the cold hard truth is that it is losing money on the EBIT line. To be specific the EBIT loss came in at AU$296k. 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. We would feel better if it turned its trailing twelve month loss of AU$677k into a profit. So we do think this stock is quite 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. Case in point: We've spotted 2 warning signs for Comms Group you should be aware of.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.