Here's Why Canfor Pulp Products (TSE:CFX) Can Afford Some Debt

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 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 can see that Canfor Pulp Products Inc. (TSE:CFX) does use debt in its business. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Canfor Pulp Products

How Much Debt Does Canfor Pulp Products Carry?

As you can see below, Canfor Pulp Products had CA$50.0m of debt, at September 2020, which is about the same as the year before. You can click the chart for greater detail. On the flip side, it has CA$30.8m in cash leading to net debt of about CA$19.2m.

A Look At Canfor Pulp Products's Liabilities

According to the last reported balance sheet, Canfor Pulp Products had liabilities of CA$136.5m due within 12 months, and liabilities of CA$217.4m due beyond 12 months. On the other hand, it had cash of CA$30.8m and CA$76.4m worth of receivables due within a year. So it has liabilities totalling CA$246.7m more than its cash and near-term receivables, combined.

While this might seem like a lot, it is not so bad since Canfor Pulp Products has a market capitalization of CA$475.6m, and so it could probably strengthen its balance sheet by raising capital if it needed to. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Canfor Pulp Products's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Over 12 months, Canfor Pulp Products made a loss at the EBIT level, and saw its revenue drop to CA$1.0b, which is a fall of 11%. That's not what we would hope to see.

Caveat Emptor

While Canfor Pulp Products'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$54m. 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. We would feel better if it turned its trailing twelve month loss of CA$32m into a profit. So in short it's a really risky stock. 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 Canfor Pulp Products is showing 2 warning signs in our investment analysis , you should know about...

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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