We Think Curaleaf Holdings (CSE:CURA) Is Taking Some Risk With Its Debt

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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. As with many other companies Curaleaf Holdings, Inc. (CSE:CURA) makes use of debt. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. 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 Curaleaf Holdings

What Is Curaleaf Holdings's Net Debt?

The image below, which you can click on for greater detail, shows that at June 2022 Curaleaf Holdings had debt of US$587.0m, up from US$338.2m in one year. On the flip side, it has US$187.1m in cash leading to net debt of about US$399.9m.

A Look At Curaleaf Holdings' Liabilities

The latest balance sheet data shows that Curaleaf Holdings had liabilities of US$382.7m due within a year, and liabilities of US$1.35b falling due after that. Offsetting this, it had US$187.1m in cash and US$63.7m in receivables that were due within 12 months. So its liabilities total US$1.49b more than the combination of its cash and short-term receivables.

This deficit isn't so bad because Curaleaf Holdings is worth US$4.60b, 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.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Even though Curaleaf Holdings's debt is only 1.6, its interest cover is really very low at 1.6. This does have us wondering if the company pays high interest because it is considered risky. In any case, it's safe to say the company has meaningful debt. One way Curaleaf Holdings could vanquish its debt would be if it stops borrowing more but continues to grow EBIT at around 12%, as it did over the last year. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Curaleaf Holdings'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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. During the last three years, Curaleaf Holdings burned a lot of cash. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Our View

While Curaleaf Holdings's interest cover makes us cautious about it, its track record of converting EBIT to free cash flow is no better. But its not so bad at growing its EBIT. Taking the abovementioned factors together we do think Curaleaf Holdings's debt poses some risks to the business. So while that leverage does boost returns on equity, we wouldn't really want to see it increase from here. In light of our reservations about the company's balance sheet, it seems sensible to check if insiders have been selling shares recently.

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.