Is AKITA Drilling (TSE:AKT.A) Using Debt In A Risky Way?

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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. We note that AKITA Drilling Ltd. (TSE:AKT.A) does have debt on its balance sheet. 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. 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, 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. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for AKITA Drilling

How Much Debt Does AKITA Drilling Carry?

The image below, which you can click on for greater detail, shows that AKITA Drilling had debt of CA$74.3m at the end of September 2020, a reduction from CA$82.3m over a year. However, it also had CA$6.68m in cash, and so its net debt is CA$67.6m.

How Strong Is AKITA Drilling's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that AKITA Drilling had liabilities of CA$12.7m due within 12 months and liabilities of CA$85.0m due beyond that. Offsetting these obligations, it had cash of CA$6.68m as well as receivables valued at CA$13.6m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CA$77.4m.

The deficiency here weighs heavily on the CA$18.4m company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. 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. The balance sheet is clearly the area to focus on when you are analysing debt. 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 made a loss at the EBIT level, and saw its revenue drop to CA$141m, which is a fall of 24%. That makes us nervous, to say the least.

Caveat Emptor

While AKITA Drilling's falling revenue is about as heartwarming as a wet blanket, arguably its earnings before interest and tax (EBIT) loss is even less appealing. Its EBIT loss was a whopping CA$19m. If you consider the significant liabilities mentioned above, we are extremely wary of this investment. 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$74m in just last twelve months, and it doesn't have much by way of liquid assets. So we think this stock is quite risky. We'd prefer to pass. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 3 warning signs for AKITA Drilling that you should be aware of before investing here.

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. 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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