Stock Analysis

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

TSXV:ECM
Source: Shutterstock

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. Importantly, Ecolomondo Corporation (CVE:ECM) does carry debt. But the more important question is: how much risk is that debt creating?

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. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Ecolomondo

How Much Debt Does Ecolomondo Carry?

As you can see below, at the end of March 2023, Ecolomondo had CA$34.7m of debt, up from CA$31.9m a year ago. Click the image for more detail. And it doesn't have much cash, so its net debt is about the same.

debt-equity-history-analysis
TSXV:ECM Debt to Equity History June 9th 2023

How Strong Is Ecolomondo's Balance Sheet?

According to the last reported balance sheet, Ecolomondo had liabilities of CA$6.11m due within 12 months, and liabilities of CA$35.5m due beyond 12 months. Offsetting this, it had CA$391.1k in cash and CA$111.7k in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CA$41.1m.

This deficit is considerable relative to its market capitalization of CA$68.0m, so it does suggest shareholders should keep an eye on Ecolomondo'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 Ecolomondo 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.

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

Over the last twelve months Ecolomondo produced an earnings before interest and tax (EBIT) loss. Indeed, it lost CA$1.6m at the EBIT level. Considering that alongside the liabilities mentioned above does not give us much confidence that company should be using so much debt. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. Another cause for caution is that is bled CA$4.3m in negative free cash flow over the last twelve months. So in short it's a really risky stock. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. We've identified 4 warning signs with Ecolomondo (at least 2 which make us uncomfortable) , and understanding them should be part of your investment process.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

Valuation is complex, but we're helping make it simple.

Find out whether Ecolomondo is potentially over or undervalued by checking out our comprehensive analysis, which includes fair value estimates, risks and warnings, dividends, insider transactions and financial health.

View the Free Analysis

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.