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. As with many other companies Zedcor Inc. (CVE:ZDC) makes use of debt. But the real question is whether this debt is making the company risky.
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. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth 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 Zedcor's Net Debt?
As you can see below, Zedcor had CA$19.9m of debt at September 2020, down from CA$23.3m a year prior. Net debt is about the same, since the it doesn't have much cash.
How Strong Is Zedcor's Balance Sheet?
The latest balance sheet data shows that Zedcor had liabilities of CA$21.9m due within a year, and liabilities of CA$9.73m falling due after that. On the other hand, it had cash of CA$192.0k and CA$3.13m worth of receivables due within a year. So its liabilities total CA$28.3m more than the combination of its cash and short-term receivables.
This deficit casts a shadow over the CA$9.22m company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. After all, Zedcor would likely require a major re-capitalisation if it had to pay its creditors today. There's no doubt that we learn most about debt from the balance sheet. But it is Zedcor's earnings that will influence how the balance sheet holds up in the future. 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.
Over 12 months, Zedcor made a loss at the EBIT level, and saw its revenue drop to CA$13m, which is a fall of 28%. That makes us nervous, to say the least.
Not only did Zedcor's revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). Indeed, it lost CA$548k at the EBIT level. If you consider the significant liabilities mentioned above, we are extremely wary of this investment. Of course, it may be able to improve its situation with a bit of luck and good execution. But we think that is unlikely since it is low on liquid assets, and made a loss of CA$6.4m in the last year. So while it's not wise to assume the company will fail, we do think it's risky. 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 instance, we've identified 3 warning signs for Zedcor (1 is potentially serious) you should be aware of.
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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