Would Sproutly Canada (CSE:SPR) Be Better Off With Less 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.' 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, Sproutly Canada Inc. (CSE:SPR) does carry debt. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

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

See our latest analysis for Sproutly Canada

How Much Debt Does Sproutly Canada Carry?

As you can see below, at the end of August 2020, Sproutly Canada had CA$9.32m of debt, up from CA$8.69m a year ago. Click the image for more detail. And it doesn't have much cash, so its net debt is about the same.

A Look At Sproutly Canada's Liabilities

The latest balance sheet data shows that Sproutly Canada had liabilities of CA$11.4m due within a year, and liabilities of CA$482.5k falling due after that. On the other hand, it had cash of CA$112.1k and CA$110.2k worth of receivables due within a year. So its liabilities total CA$11.6m more than the combination of its cash and short-term receivables.

This deficit is considerable relative to its market capitalization of CA$15.9m, so it does suggest shareholders should keep an eye on Sproutly Canada's use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Sproutly Canada will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Over 12 months, Sproutly Canada reported revenue of CA$1.0m, which is a gain of 612%, although it did not report any earnings before interest and tax. That's virtually the hole-in-one of revenue growth!

Caveat Emptor

While we can certainly appreciate Sproutly Canada's revenue growth, its earnings before interest and tax (EBIT) loss is not ideal. Its EBIT loss was a whopping CA$6.5m. 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. However, it doesn't help that it burned through CA$2.6m of cash over the last year. So in short it's a really risky stock. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 5 warning signs for Sproutly Canada you should be aware of, and 2 of them are concerning.

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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