Legendary fund manager Li Lu (who Charlie Munger backed) once said, ‘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. We can see that Future Farm Technologies Inc. (CNSX:FFT) does use debt in its business. But should shareholders be worried about its use of debt?
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. 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, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.
What Is Future Farm Technologies’s Debt?
You can click the graphic below for the historical numbers, but it shows that as of August 2019 Future Farm Technologies had CA$2.58m of debt, an increase on CA$1.82m, over one year. Net debt is about the same, since the it doesn’t have much cash.
How Strong Is Future Farm Technologies’s Balance Sheet?
The latest balance sheet data shows that Future Farm Technologies had liabilities of CA$6.92m due within a year, and liabilities of CA$151.9k falling due after that. Offsetting these obligations, it had cash of CA$16.4k as well as receivables valued at CA$338.2k due within 12 months. So its liabilities total CA$6.71m more than the combination of its cash and short-term receivables.
This deficit is considerable relative to its market capitalization of CA$8.54m, so it does suggest shareholders should keep an eye on Future Farm Technologies’s use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution. There’s no doubt that we learn most about debt from the balance sheet. But you can’t view debt in total isolation; since Future Farm Technologies 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.
Over 12 months, Future Farm Technologies reported revenue of CA$3.8m, which is a gain of 47%, although it did not report any earnings before interest and tax. Shareholders probably have their fingers crossed that it can grow its way to profits.
Despite the top line growth, Future Farm Technologies still had negative earnings before interest and tax (EBIT), over the last year. Indeed, it lost a very considerable CA$8.1m at the EBIT level. When we look at that and recall the liabilities on its balance sheet, relative to cash, it seems unwise to us for the company to have any debt. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. However, it doesn’t help that it burned through CA$4.1m of cash over the last year. So suffice it to say we consider the stock very risky. When we look at a riskier company, we like to check how their profits (or losses) are trending over time. Today, we’re providing readers this interactive graph showing how Future Farm Technologies’s profit, revenue, and operating cashflow have changed over the last few years.
If, after all that, you’re more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.
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