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 note that AKITA Drilling Ltd. (TSE:AKT.A) does have debt on its balance sheet. But should shareholders be worried about its use of debt?
When Is Debt A Problem?
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. If things get really bad, the lenders can take control of the business. 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, 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 AKITA Drilling Carry?
You can click the graphic below for the historical numbers, but it shows that AKITA Drilling had CA$79.7m of debt in June 2020, down from CA$84.3m, one year before. However, because it has a cash reserve of CA$10.1m, its net debt is less, at about CA$69.6m.
How Strong Is AKITA Drilling's Balance Sheet?
We can see from the most recent balance sheet that AKITA Drilling had liabilities of CA$16.6m falling due within a year, and liabilities of CA$87.5m due beyond that. On the other hand, it had cash of CA$10.1m and CA$17.5m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by CA$76.5m.
This deficit casts a shadow over the CA$16.6m company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. After all, AKITA Drilling would likely require a major re-capitalisation if it had to pay its creditors today. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if AKITA Drilling can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.
Over 12 months, AKITA Drilling saw its revenue hold pretty steady, and it did not report positive earnings before interest and tax. While that's not too bad, we'd prefer see growth.
Importantly, AKITA Drilling had an earnings before interest and tax (EBIT) loss over the last year. Indeed, it lost a very considerable CA$16.4m at the EBIT level. Combining this information with the significant liabilities we already touched on makes us very hesitant about this stock, to say the least. That said, it is possible that the company will turn its fortunes around. Nevertheless, we would not bet on it given that it lost CA$70.8m in just last twelve months, and it doesn't have much by way of liquid assets. So while it's not wise to assume the company will fail, we do think it's risky. 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. For instance, we've identified 3 warning signs for AKITA Drilling that you should be aware of.
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.
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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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