Lophos Holdings (CSE:MESC) Is Carrying A Fair Bit Of Debt

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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. As with many other companies Lophos Holdings Inc. (CSE:MESC) makes use of debt. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. 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. 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 examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Lophos Holdings

How Much Debt Does Lophos Holdings Carry?

The chart below, which you can click on for greater detail, shows that Lophos Holdings had CA$2.07m in debt in September 2023; about the same as the year before. However, because it has a cash reserve of CA$576.0k, its net debt is less, at about CA$1.49m.

How Healthy Is Lophos Holdings' Balance Sheet?

According to the last reported balance sheet, Lophos Holdings had liabilities of CA$574.8k due within 12 months, and liabilities of CA$2.05m due beyond 12 months. On the other hand, it had cash of CA$576.0k and CA$180.9k worth of receivables due within a year. So its liabilities total CA$1.86m more than the combination of its cash and short-term receivables.

While this might seem like a lot, it is not so bad since Lophos Holdings has a market capitalization of CA$8.16m, and so it could probably strengthen its balance sheet by raising capital if it needed to. But it's clear that we should definitely closely examine whether it can manage its debt without dilution. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Lophos Holdings 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 Lophos Holdings can significantly advance the business plan before too long, because it doesn't have any significant revenue at the moment.

Caveat Emptor

Importantly, Lophos Holdings had an earnings before interest and tax (EBIT) loss over the last year. Its EBIT loss was a whopping CA$991k. 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$479k in negative free cash flow over the last twelve months. So in short it's a really risky stock. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. We've identified 5 warning signs with Lophos Holdings (at least 4 which are a bit 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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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.