Howard Marks put it nicely when he said that, rather than worrying about share price volatility, ‘The possibility of permanent loss is the risk I worry about… and every practical investor I know worries about.’ 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 note that Chemesis International Inc. (CNSX:CSI) 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 is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Part and parcel of capitalism is the process of ‘creative destruction’ where failed businesses are mercilessly liquidated by their bankers. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Having said that, the most common situation is where a company manages its debt reasonably well – and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.
How Much Debt Does Chemesis International Carry?
As you can see below, at the end of March 2019, Chemesis International had CA$3.13m of debt, up from none a year ago. Click the image for more detail. However, because it has a cash reserve of CA$1.73m, its net debt is less, at about CA$1.40m.
A Look At Chemesis International’s Liabilities
According to the balance sheet data, Chemesis International had liabilities of CA$10.9m due within 12 months, but no longer term liabilities. Offsetting this, it had CA$1.73m in cash and CA$3.25m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CA$5.96m.
Since publicly traded Chemesis International shares are worth a total of CA$73.8m, it seems unlikely that this level of liabilities would be a major threat. Having said that, it’s clear that we should continue to monitor its balance sheet, lest it change for the worse. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Chemesis International’s earnings that will influence how the balance sheet holds up in the future. So when considering debt, it’s definitely worth looking at the earnings trend. Click here for an interactive snapshot.
While it hasn’t made a profit, at least Chemesis International booked its first revenue as a publicly listed company, in the last twelve months.
Over the last twelve months Chemesis International produced an earnings before interest and tax (EBIT) loss. Its EBIT loss was a whopping CA$8.9m. 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. 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$13m in negative free cash flow over the last twelve months. So suffice it to say we consider the stock very risky. When I consider a company to be a bit risky, I think it is responsible to check out whether insiders have been reporting any share sales. Luckily, you can click here ito see our graphic depicting Chemesis International insider transactions.
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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