Here's Why Clean Seed Capital Group (CVE:CSX) Can Manage Its Debt Responsibly

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We can see that Clean Seed Capital Group Ltd. (CVE:CSX) does use debt in its business. But the real question is whether this debt is making the company risky.

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. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Clean Seed Capital Group

What Is Clean Seed Capital Group's Debt?

The image below, which you can click on for greater detail, shows that Clean Seed Capital Group had debt of CA$2.43m at the end of December 2020, a reduction from CA$4.52m over a year. However, it also had CA$1.29m in cash, and so its net debt is CA$1.15m.

How Strong Is Clean Seed Capital Group's Balance Sheet?

According to the last reported balance sheet, Clean Seed Capital Group had liabilities of CA$2.11m due within 12 months, and liabilities of CA$1.38m due beyond 12 months. Offsetting this, it had CA$1.29m in cash and CA$22.2k in receivables that were due within 12 months. So its liabilities total CA$2.19m more than the combination of its cash and short-term receivables.

Of course, Clean Seed Capital Group has a market capitalization of CA$44.3m, so these liabilities are probably manageable. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Clean Seed Capital Group's net debt is only 0.32 times its EBITDA. And its EBIT easily covers its interest expense, being 10.3 times the size. So you could argue it is no more threatened by its debt than an elephant is by a mouse. It was also good to see that despite losing money on the EBIT line last year, Clean Seed Capital Group turned things around in the last 12 months, delivering and EBIT of CA$2.9m. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Clean Seed Capital Group 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So it is important to check how much of its earnings before interest and tax (EBIT) converts to actual free cash flow. In the last year, Clean Seed Capital Group's free cash flow amounted to 45% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Our View

The good news is that Clean Seed Capital Group's demonstrated ability handle its debt, based on its EBITDA, delights us like a fluffy puppy does a toddler. And the good news does not stop there, as its interest cover also supports that impression! Looking at all the aforementioned factors together, it strikes us that Clean Seed Capital Group can handle its debt fairly comfortably. On the plus side, this leverage can boost shareholder returns, but the potential downside is more risk of loss, so it's worth monitoring the balance sheet. 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. These risks can be hard to spot. Every company has them, and we've spotted 4 warning signs for Clean Seed Capital Group you should know about.

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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