Stock Analysis

Here's Why Earthworks Industries (CVE:EWK) Can Afford Some Debt

TSXV:EWK
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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 might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We can see that Earthworks Industries Inc. (CVE:EWK) does use debt in its business. 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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. 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 Earthworks Industries

How Much Debt Does Earthworks Industries Carry?

As you can see below, Earthworks Industries had CA$7.97m of debt, at August 2021, which is about the same as the year before. You can click the chart for greater detail. However, it does have CA$386.7k in cash offsetting this, leading to net debt of about CA$7.58m.

debt-equity-history-analysis
TSXV:EWK Debt to Equity History December 24th 2021

A Look At Earthworks Industries' Liabilities

Zooming in on the latest balance sheet data, we can see that Earthworks Industries had liabilities of CA$2.02m due within 12 months and liabilities of CA$6.75m due beyond that. Offsetting these obligations, it had cash of CA$386.7k as well as receivables valued at CA$21.3k due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CA$8.36m.

This deficit isn't so bad because Earthworks Industries is worth CA$24.8m, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Earthworks Industries 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.

Given it has no significant operating revenue at the moment, shareholders will be hoping Earthworks Industries can make progress and gain better traction for the business, before it runs low on cash.

Caveat Emptor

Importantly, Earthworks Industries had an earnings before interest and tax (EBIT) loss over the last year. Indeed, it lost CA$462k 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. 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$460k in negative free cash flow over the last twelve months. So suffice it to say we do consider the stock to be risky. 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. We've identified 5 warning signs with Earthworks Industries (at least 2 which are a bit unpleasant) , and understanding them should be part of your investment process.

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.

Valuation is complex, but we're here to simplify it.

Discover if Earthworks Industries might be undervalued or overvalued with our detailed analysis, featuring fair value estimates, potential risks, dividends, insider trades, and its financial condition.

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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.