Is Rocky Mountain Liquor (CVE:RUM) Using Too Much Debt?

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. We can see that Rocky Mountain Liquor Inc. (CVE:RUM) does use debt in its business. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

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. If things get really bad, the lenders can take control of the business. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Rocky Mountain Liquor

What Is Rocky Mountain Liquor's Net Debt?

The image below, which you can click on for greater detail, shows that Rocky Mountain Liquor had debt of CA$5.21m at the end of December 2020, a reduction from CA$7.85m over a year. On the flip side, it has CA$147.0k in cash leading to net debt of about CA$5.06m.

How Healthy Is Rocky Mountain Liquor's Balance Sheet?

The latest balance sheet data shows that Rocky Mountain Liquor had liabilities of CA$7.39m due within a year, and liabilities of CA$12.4m falling due after that. Offsetting this, it had CA$147.0k in cash and CA$438.2k in receivables that were due within 12 months. So its liabilities total CA$19.2m more than the combination of its cash and short-term receivables.

This deficit casts a shadow over the CA$8.07m company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. At the end of the day, Rocky Mountain Liquor would probably need a major re-capitalization if its creditors were to demand repayment.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Rocky Mountain Liquor has net debt worth 1.7 times EBITDA, which isn't too much, but its interest cover looks a bit on the low side, with EBIT at only 2.6 times the interest expense. While that doesn't worry us too much, it does suggest the interest payments are somewhat of a burden. Notably, Rocky Mountain Liquor's EBIT launched higher than Elon Musk, gaining a whopping 162% on last year. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Rocky Mountain Liquor 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.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we always check how much of that EBIT is translated into free cash flow. Over the last three years, Rocky Mountain Liquor actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Our View

We feel some trepidation about Rocky Mountain Liquor's difficulty level of total liabilities, but we've got positives to focus on, too. To wit both its conversion of EBIT to free cash flow and EBIT growth rate were encouraging signs. Looking at all the angles mentioned above, it does seem to us that Rocky Mountain Liquor is a somewhat risky investment as a result of its debt. Not all risk is bad, as it can boost share price returns if it pays off, but this debt risk is worth keeping in mind. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 3 warning signs for Rocky Mountain Liquor you should be aware of, and 2 of them are a bit concerning.

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.

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This article by Simply Wall St is general in nature. 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.
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