Is Crescita Therapeutics (TSE:CTX) Using Debt Sensibly?

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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. Importantly, Crescita Therapeutics Inc. (TSE:CTX) does carry debt. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

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. 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. 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 think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Crescita Therapeutics

What Is Crescita Therapeutics's Debt?

The image below, which you can click on for greater detail, shows that at June 2021 Crescita Therapeutics had debt of CA$3.02m, up from CA$923.0k in one year. But on the other hand it also has CA$13.1m in cash, leading to a CA$10.1m net cash position.

How Healthy Is Crescita Therapeutics' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Crescita Therapeutics had liabilities of CA$5.80m due within 12 months and liabilities of CA$1.88m due beyond that. Offsetting this, it had CA$13.1m in cash and CA$1.93m in receivables that were due within 12 months. So it actually has CA$7.39m more liquid assets than total liabilities.

This excess liquidity is a great indication that Crescita Therapeutics' balance sheet is almost as strong as Fort Knox. On this view, lenders should feel as safe as the beloved of a black-belt karate master. Simply put, the fact that Crescita Therapeutics has more cash than debt is arguably a good indication that it can manage its debt safely. 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 Crescita Therapeutics 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.

In the last year Crescita Therapeutics had a loss before interest and tax, and actually shrunk its revenue by 28%, to CA$12m. That makes us nervous, to say the least.

So How Risky Is Crescita Therapeutics?

Although Crescita Therapeutics had an earnings before interest and tax (EBIT) loss over the last twelve months, it generated positive free cash flow of CA$4.3m. So taking that on face value, and considering the net cash situation, we don't think that the stock is too risky in the near term. There's no doubt the next few years will be crucial to how the business matures. 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. For example, we've discovered 2 warning signs for Crescita Therapeutics 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.

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.

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