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

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. As with many other companies Earthworks Industries Inc. (CVE:EWK) makes use of debt. But is this debt a concern to shareholders?

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Earthworks Industries

What Is Earthworks Industries's Debt?

You can click the graphic below for the historical numbers, but it shows that as of May 2023 Earthworks Industries had CA$9.20m of debt, an increase on CA$8.14m, over one year. However, it also had CA$781.7k in cash, and so its net debt is CA$8.41m.

How Healthy Is Earthworks Industries' Balance Sheet?

According to the last reported balance sheet, Earthworks Industries had liabilities of CA$1.95m due within 12 months, and liabilities of CA$8.12m due beyond 12 months. On the other hand, it had cash of CA$781.7k and CA$6.1k worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by CA$9.29m.

While this might seem like a lot, it is not so bad since Earthworks Industries has a market capitalization of CA$36.6m, and so it could probably strengthen its balance sheet by raising capital if it needed to. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. When analysing debt levels, the balance sheet is the obvious place to start. But it is Earthworks Industries'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.

It seems likely shareholders hope that Earthworks Industries 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 Earthworks Industries produced an earnings before interest and tax (EBIT) loss. To be specific the EBIT loss came in at CA$1.4m. 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$529k in negative free cash flow over the last twelve months. So suffice it to say we do consider the stock to be 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. We've identified 5 warning signs with Earthworks Industries (at least 3 which are concerning) , 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.

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.