Is Nanalysis Scientific (CVE:NSCI) Using Debt Sensibly?

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. As with many other companies Nanalysis Scientific Corp. (CVE:NSCI) makes use of debt. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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.

Check out our latest analysis for Nanalysis Scientific

What Is Nanalysis Scientific's Debt?

The image below, which you can click on for greater detail, shows that at September 2020 Nanalysis Scientific had debt of CA$3.09m, up from CA$973.0k in one year. But it also has CA$4.47m in cash to offset that, meaning it has CA$1.38m net cash.

How Strong Is Nanalysis Scientific's Balance Sheet?

The latest balance sheet data shows that Nanalysis Scientific had liabilities of CA$5.65m due within a year, and liabilities of CA$3.53m falling due after that. Offsetting these obligations, it had cash of CA$4.47m as well as receivables valued at CA$2.66m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CA$2.05m.

Given Nanalysis Scientific has a market capitalization of CA$32.0m, it's hard to believe these liabilities pose much threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. While it does have liabilities worth noting, Nanalysis Scientific also has more cash than debt, so we're pretty confident it can manage its debt safely. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Nanalysis Scientific 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 Nanalysis Scientific had a loss before interest and tax, and actually shrunk its revenue by 19%, to CA$7.3m. That's not what we would hope to see.

So How Risky Is Nanalysis Scientific?

We have no doubt that loss making companies are, in general, riskier than profitable ones. And in the last year Nanalysis Scientific had an earnings before interest and tax (EBIT) loss, truth be told. And over the same period it saw negative free cash outflow of CA$2.0m and booked a CA$2.5m accounting loss. However, it has net cash of CA$1.38m, so it has a bit of time before it will need more capital. Summing up, we're a little skeptical of this one, as it seems fairly risky in the absence of free cashflow. 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. Be aware that Nanalysis Scientific is showing 2 warning signs in our investment analysis , and 1 of those is concerning...

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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