Here's Why EarthRenew (CSE:ERTH) Can Afford Some Debt

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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 note that EarthRenew Inc. (CSE:ERTH) 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?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for EarthRenew

What Is EarthRenew's Net Debt?

As you can see below, at the end of September 2021, EarthRenew had CA$3.08m of debt, up from none a year ago. Click the image for more detail. On the flip side, it has CA$230.7k in cash leading to net debt of about CA$2.85m.

How Healthy Is EarthRenew's Balance Sheet?

The latest balance sheet data shows that EarthRenew had liabilities of CA$4.86m due within a year, and liabilities of CA$11.9m falling due after that. Offsetting these obligations, it had cash of CA$230.7k as well as receivables valued at CA$2.73m due within 12 months. So its liabilities total CA$13.8m more than the combination of its cash and short-term receivables.

This is a mountain of leverage relative to its market capitalization of CA$21.2m. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since EarthRenew will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

In the last year EarthRenew wasn't profitable at an EBIT level, but managed to grow its revenue by 879%, to CA$4.8m. When it comes to revenue growth, that's like nailing the game winning 3-pointer!

Caveat Emptor

Despite the top line growth, EarthRenew still had an earnings before interest and tax (EBIT) loss over the last year. Its EBIT loss was a whopping CA$4.1m. Considering that alongside the liabilities mentioned above does not give us much confidence that company should be using so much 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$3.2m of cash over the last year. So in short it's a really risky stock. 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. We've identified 6 warning signs with EarthRenew (at least 3 which are a bit concerning) , and understanding them should be part of your investment process.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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.