Here's Why Luff Enterprises (CSE:LUFF) Can Afford Some Debt

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. We note that Luff Enterprises Ltd. (CSE:LUFF) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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.

See our latest analysis for Luff Enterprises

What Is Luff Enterprises's Debt?

As you can see below, at the end of March 2021, Luff Enterprises had CA$2.59m of debt, up from none a year ago. Click the image for more detail. However, it also had CA$1.37m in cash, and so its net debt is CA$1.23m.

How Healthy Is Luff Enterprises' Balance Sheet?

We can see from the most recent balance sheet that Luff Enterprises had liabilities of CA$2.32m falling due within a year, and liabilities of CA$627.5k due beyond that. Offsetting this, it had CA$1.37m in cash and CA$1.49m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CA$86.9k.

Having regard to Luff Enterprises' size, it seems that its liquid assets are well balanced with its total liabilities. So while it's hard to imagine that the CA$11.9m company is struggling for cash, we still think it's worth monitoring its balance sheet. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Luff Enterprises will need earnings to service that debt. 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.

It seems likely shareholders hope that Luff Enterprises can significantly advance the business plan before too long, because it doesn't have any significant revenue at the moment.

Caveat Emptor

While Luff Enterprises's falling revenue is about as heartwarming as a wet blanket, arguably its earnings before interest and tax (EBIT) loss is even less appealing. Indeed, it lost a very considerable CA$3.2m 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. However, it doesn't help that it burned through CA$2.9m of cash over the last year. So suffice it to say we consider the stock very risky. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. For example, we've discovered 6 warning signs for Luff Enterprises (4 are a bit unpleasant!) that you should be aware of before investing here.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

If you're looking for stocks to buy, use the lowest-cost* platform that is rated #1 Overall by Barron’s, Interactive Brokers. Trade stocks, options, futures, forex, bonds and funds on 135 markets, all from a single integrated account. Promoted

This article by Simply Wall St is general in nature. 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.
^*Interactive Brokers Rated Lowest Cost Broker by StockBrokers.com Annual Online Review 2020

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.