Stock Analysis

Here's Why Ecolomondo (CVE:ECM) Can Afford Some Debt

TSXV:ECM
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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.' 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. We can see that Ecolomondo Corporation (CVE:ECM) 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. 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. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Ecolomondo

What Is Ecolomondo's Debt?

The image below, which you can click on for greater detail, shows that at September 2020 Ecolomondo had debt of CA$20.7m, up from CA$1.72m in one year. However, it does have CA$6.20m in cash offsetting this, leading to net debt of about CA$14.5m.

debt-equity-history-analysis
TSXV:ECM Debt to Equity History December 31st 2020

How Healthy Is Ecolomondo's Balance Sheet?

We can see from the most recent balance sheet that Ecolomondo had liabilities of CA$7.17m falling due within a year, and liabilities of CA$20.9m due beyond that. Offsetting this, it had CA$6.20m in cash and CA$451.6k in receivables that were due within 12 months. So it has liabilities totalling CA$21.4m more than its cash and near-term receivables, combined.

Ecolomondo has a market capitalization of CA$62.1m, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Ecolomondo 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.

It seems likely shareholders hope that Ecolomondo can significantly advance the business plan before too long, because it doesn't have any significant revenue at the moment.

Caveat Emptor

While Ecolomondo'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$1.4m at the EBIT level. 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. Another cause for caution is that is bled CA$15m in negative free cash flow over the last twelve months. So suffice it to say we consider the stock very risky. 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 example, we've discovered 4 warning signs for Ecolomondo (2 are a bit unpleasant!) that you should be aware of before investing here.

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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