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.' 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 note that Evergreen Gaming Corporation (CVE:TNA) does have debt on its balance sheet. 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. 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. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.
How Much Debt Does Evergreen Gaming Carry?
The image below, which you can click on for greater detail, shows that Evergreen Gaming had debt of US$4.44m at the end of September 2021, a reduction from US$7.73m over a year. But on the other hand it also has US$23.0m in cash, leading to a US$18.6m net cash position.
How Strong Is Evergreen Gaming's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Evergreen Gaming had liabilities of US$6.80m due within 12 months and liabilities of US$5.50m due beyond that. Offsetting these obligations, it had cash of US$23.0m as well as receivables valued at US$1.14m due within 12 months. So it actually has US$11.9m more liquid assets than total liabilities.
This excess liquidity is a great indication that Evergreen Gaming's balance sheet is almost as strong as Fort Knox. On this view, lenders should feel as safe as the beloved of a black-belt karate master. Succinctly put, Evergreen Gaming boasts net cash, so it's fair to say it does not have a heavy debt load!
Although Evergreen Gaming made a loss at the EBIT level, last year, it was also good to see that it generated US$5.4m in EBIT over the last twelve months. When analysing debt levels, the balance sheet is the obvious place to start. But it is Evergreen Gaming'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.
Finally, a company can only pay off debt with cold hard cash, not accounting profits. Evergreen Gaming may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Happily for any shareholders, Evergreen Gaming actually produced more free cash flow than EBIT over the last year. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.
While it is always sensible to investigate a company's debt, in this case Evergreen Gaming has US$18.6m in net cash and a decent-looking balance sheet. The cherry on top was that in converted 112% of that EBIT to free cash flow, bringing in US$6.1m. So we don't think Evergreen Gaming's use of debt is risky. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. For instance, we've identified 3 warning signs for Evergreen Gaming (1 is a bit unpleasant) you should be aware of.
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. 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.