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.' 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 can see that SQI Diagnostics Inc. (CVE:SQD) does use debt in its business. But the real question is whether this debt is making the company risky.
What Risk Does Debt Bring?
Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, 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 SQI Diagnostics
What Is SQI Diagnostics's Net Debt?
The chart below, which you can click on for greater detail, shows that SQI Diagnostics had CA$2.18m in debt in March 2021; about the same as the year before. However, its balance sheet shows it holds CA$3.78m in cash, so it actually has CA$1.61m net cash.
How Strong Is SQI Diagnostics' Balance Sheet?
Zooming in on the latest balance sheet data, we can see that SQI Diagnostics had liabilities of CA$1.99m due within 12 months and liabilities of CA$4.68m due beyond that. Offsetting this, it had CA$3.78m in cash and CA$205.0k in receivables that were due within 12 months. So its liabilities total CA$2.67m more than the combination of its cash and short-term receivables.
Given SQI Diagnostics has a market capitalization of CA$72.5m, it's hard to believe these liabilities pose much threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. Despite its noteworthy liabilities, SQI Diagnostics boasts net cash, so it's fair to say it does not have a heavy debt load! When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since SQI Diagnostics 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, SQI Diagnostics made a loss at the EBIT level, and saw its revenue drop to CA$1.0m, which is a fall of 38%. That makes us nervous, to say the least.
So How Risky Is SQI Diagnostics?
Statistically speaking companies that lose money are riskier than those that make money. And the fact is that over the last twelve months SQI Diagnostics lost money at the earnings before interest and tax (EBIT) line. Indeed, in that time it burnt through CA$8.3m of cash and made a loss of CA$12m. With only CA$1.61m on the balance sheet, it would appear that its going to need to raise capital again soon. Overall, we'd say the stock is a bit risky, and we're usually very cautious until we see positive free cash flow. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. For instance, we've identified 6 warning signs for SQI Diagnostics (3 are a bit unpleasant) you should be aware of.
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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About TSXV:SQD.H
SQI Diagnostics
A precision medicine company, discovers, develops, and commercializes rapid diagnostic testing services for healthcare providers, patients, and consumers worldwide.
Medium-low and slightly overvalued.