The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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. Importantly, Aegis Brands Inc. (TSE:AEG) does carry debt. But is this debt a concern to shareholders?
What Risk Does Debt Bring?
Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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 Aegis Brands
What Is Aegis Brands's Net Debt?
The image below, which you can click on for greater detail, shows that at June 2023 Aegis Brands had debt of CA$29.7m, up from CA$950.0k in one year. However, because it has a cash reserve of CA$3.60m, its net debt is less, at about CA$26.1m.
How Strong Is Aegis Brands' Balance Sheet?
We can see from the most recent balance sheet that Aegis Brands had liabilities of CA$9.75m falling due within a year, and liabilities of CA$36.6m due beyond that. On the other hand, it had cash of CA$3.60m and CA$3.60m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by CA$39.1m.
When you consider that this deficiency exceeds the company's CA$34.1m market capitalization, you might well be inclined to review the balance sheet intently. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price. 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 Aegis Brands 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.
In the last year Aegis Brands wasn't profitable at an EBIT level, but managed to grow its revenue by 110%, to CA$25m. So there's no doubt that shareholders are cheering for growth
Caveat Emptor
Even though Aegis Brands managed to grow its top line quite deftly, the cold hard truth is that it is losing money on the EBIT line. Its EBIT loss was a whopping CA$6.6m. When we look at that alongside the significant liabilities, we're not particularly confident about the company. We'd want to see some strong near-term improvements before getting too interested in the stock. Not least because it burned through CA$1.3m in negative free cash flow over the last year. So suffice it to say we 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 4 warning signs with Aegis Brands (at least 3 which don't sit too well with us) , and understanding them should be part of your investment process.
If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.
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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.
About TSX:AEG
Slightly overvalued very low.
