Is Ceylon Graphite (CVE:CYL) Using Too Much Debt?

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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. Importantly, Ceylon Graphite Corp. (CVE:CYL) does carry debt. But is this debt a concern to shareholders?

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 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, 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 Ceylon Graphite

What Is Ceylon Graphite's Debt?

The chart below, which you can click on for greater detail, shows that Ceylon Graphite had CA$2.01m in debt in December 2022; about the same as the year before. However, because it has a cash reserve of CA$1.06m, its net debt is less, at about CA$950.6k.

A Look At Ceylon Graphite's Liabilities

Zooming in on the latest balance sheet data, we can see that Ceylon Graphite had liabilities of CA$3.64m due within 12 months and no liabilities due beyond that. Offsetting this, it had CA$1.06m in cash and CA$80.8k in receivables that were due within 12 months. So it has liabilities totalling CA$2.50m more than its cash and near-term receivables, combined.

Ceylon Graphite has a market capitalization of CA$11.9m, so it could very likely raise cash to ameliorate 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. There's no doubt that we learn most about debt from the balance sheet. But it is Ceylon Graphite's earnings that will influence how the balance sheet holds up in the future. 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.

Given its lack of meaningful operating revenue, investors are probably hoping that Ceylon Graphite finds some valuable resources, before it runs out of money.

Caveat Emptor

Over the last twelve months Ceylon Graphite produced an earnings before interest and tax (EBIT) loss. Indeed, it lost a very considerable CA$2.5m at the EBIT level. 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. Another cause for caution is that is bled CA$2.5m in negative free cash flow over the last twelve months. 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. For instance, we've identified 6 warning signs for Ceylon Graphite (5 are a bit concerning) 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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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.