Here's Why Adastra Holdings (CSE:XTRX) Can Afford Some 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.' 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. Importantly, Adastra Holdings Ltd. (CSE:XTRX) does carry debt. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

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. If things get really bad, the lenders can take control of the business. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Adastra Holdings

What Is Adastra Holdings's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of June 2023 Adastra Holdings had CA$3.89m of debt, an increase on CA$3.58m, over one year. However, it also had CA$2.04m in cash, and so its net debt is CA$1.85m.

A Look At Adastra Holdings' Liabilities

Zooming in on the latest balance sheet data, we can see that Adastra Holdings had liabilities of CA$14.0m due within 12 months and liabilities of CA$872.6k due beyond that. On the other hand, it had cash of CA$2.04m and CA$3.72m worth of receivables due within a year. So it has liabilities totalling CA$9.12m more than its cash and near-term receivables, combined.

This is a mountain of leverage relative to its market capitalization of CA$14.0m. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry. When analysing debt levels, the balance sheet is the obvious place to start. But it is Adastra Holdings'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, Adastra Holdings reported revenue of CA$21m, which is a gain of 128%, although it did not report any earnings before interest and tax. So there's no doubt that shareholders are cheering for growth

Caveat Emptor

While we can certainly appreciate Adastra Holdings's revenue growth, its earnings before interest and tax (EBIT) loss is not ideal. To be specific the EBIT loss came in at CA$744k. 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. For example, we would not want to see a repeat of last year's loss of CA$4.6m. In the meantime, we consider the stock very risky. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. For example, we've discovered 2 warning signs for Adastra Holdings (1 can't be ignored!) that you should be aware of before investing here.

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.