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

By
Simply Wall St
Published
January 10, 2022
CNSX:LUFF
Source: Shutterstock

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.' 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, Luff Enterprises Ltd. (CSE:LUFF) does carry debt. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

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. 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. 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 examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Luff Enterprises

How Much Debt Does Luff Enterprises Carry?

As you can see below, at the end of September 2021, Luff Enterprises had CA$2.43m of debt, up from CA$425.5k a year ago. Click the image for more detail. However, because it has a cash reserve of CA$576.5k, its net debt is less, at about CA$1.86m.

debt-equity-history-analysis
CNSX:LUFF Debt to Equity History January 10th 2022

A Look At Luff Enterprises' Liabilities

The latest balance sheet data shows that Luff Enterprises had liabilities of CA$2.41m due within a year, and liabilities of CA$433.0k falling due after that. Offsetting this, it had CA$576.5k in cash and CA$1.13m in receivables that were due within 12 months. So it has liabilities totalling CA$1.14m more than its cash and near-term receivables, combined.

Of course, Luff Enterprises has a market capitalization of CA$8.63m, so these liabilities are probably manageable. 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 Luff Enterprises'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.

Over 12 months, Luff Enterprises reported revenue of CA$862k, which is a gain of 1,146%, although it did not report any earnings before interest and tax. That's virtually the hole-in-one of revenue growth!

Caveat Emptor

Despite the top line growth, Luff Enterprises still had an earnings before interest and tax (EBIT) loss over the last year. Its EBIT loss was a whopping CA$3.1m. Considering that alongside the liabilities mentioned above does not give us much confidence that company should be using so much debt. So we think its balance sheet is a little strained, though not beyond repair. Another cause for caution is that is bled CA$2.1m 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. We've identified 4 warning signs with Luff Enterprises (at least 2 which are concerning) , and understanding them should be part of your investment process.

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.

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