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.' 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. Importantly, Canfor Pulp Products Inc. (TSE:CFX) does carry debt. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

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. 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. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Canfor Pulp Products

What Is Canfor Pulp Products's Net Debt?

As you can see below, Canfor Pulp Products had CA$50.0m of debt at December 2020, down from CA$64.0m a year prior. However, it does have CA$6.80m in cash offsetting this, leading to net debt of about CA$43.2m.

A Look At Canfor Pulp Products' Liabilities

We can see from the most recent balance sheet that Canfor Pulp Products had liabilities of CA$162.6m falling due within a year, and liabilities of CA$225.7m due beyond that. Offsetting this, it had CA$6.80m in cash and CA$103.9m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CA$277.6m.

This deficit isn't so bad because Canfor Pulp Products is worth CA$585.8m, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Canfor Pulp Products can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

In the last year Canfor Pulp Products had a loss before interest and tax, and actually shrunk its revenue by 8.9%, to CA$991m. We would much prefer see growth.

Caveat Emptor

Over the last twelve months Canfor Pulp Products produced an earnings before interest and tax (EBIT) loss. Indeed, it lost CA$58m 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. So we think its balance sheet is a little strained, though not beyond repair. For example, we would not want to see a repeat of last year's loss of CA$22m. So to be blunt we do think it is risky. For riskier companies like Canfor Pulp Products I always like to keep an eye on whether insiders are buying or selling. So click here if you want to find out for yourself.

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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