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.' 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 note that Zedcor Inc. (CVE:ZDC) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.
Why Does Debt Bring Risk?
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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.
What Is Zedcor's Net Debt?
As you can see below, Zedcor had CA$19.3m of debt at March 2021, down from CA$22.0m a year prior. Net debt is about the same, since the it doesn't have much cash.
How Healthy Is Zedcor's Balance Sheet?
The latest balance sheet data shows that Zedcor had liabilities of CA$6.80m due within a year, and liabilities of CA$21.0m falling due after that. On the other hand, it had cash of CA$180.0k and CA$4.43m worth of receivables due within a year. So it has liabilities totalling CA$23.2m more than its cash and near-term receivables, combined.
When you consider that this deficiency exceeds the company's CA$16.2m market capitalization, you might well be inclined to review the balance sheet intently. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price. 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 when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.
In the last year Zedcor had a loss before interest and tax, and actually shrunk its revenue by 12%, to CA$14m. We would much prefer see growth.
While Zedcor's falling revenue is about as heartwarming as a wet blanket, arguably its earnings before interest and tax (EBIT) loss is even less appealing. Indeed, it lost CA$113k at the EBIT level. Considering that alongside the liabilities mentioned above make us nervous about the company. We'd want to see some strong near-term improvements before getting too interested in the stock. It's fair to say the loss of CA$4.2m didn't encourage us either; we'd like to see a profit. And until that time we think this is a risky stock. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 3 warning signs for Zedcor that you should be aware of.
If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.
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