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.' 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. We can see that Delta 9 Cannabis Inc. (TSE:DN) does use debt in its business. But should shareholders be worried about its use of debt?
What Risk Does Debt Bring?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.
What Is Delta 9 Cannabis's Debt?
The image below, which you can click on for greater detail, shows that at December 2020 Delta 9 Cannabis had debt of CA$25.1m, up from CA$20.3m in one year. On the flip side, it has CA$8.08m in cash leading to net debt of about CA$17.0m.
How Strong Is Delta 9 Cannabis' Balance Sheet?
We can see from the most recent balance sheet that Delta 9 Cannabis had liabilities of CA$15.8m falling due within a year, and liabilities of CA$27.7m due beyond that. Offsetting this, it had CA$8.08m in cash and CA$5.27m in receivables that were due within 12 months. So its liabilities total CA$30.1m more than the combination of its cash and short-term receivables.
This deficit isn't so bad because Delta 9 Cannabis is worth CA$60.2m, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Delta 9 Cannabis's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.
In the last year Delta 9 Cannabis wasn't profitable at an EBIT level, but managed to grow its revenue by 63%, to CA$52m. With any luck the company will be able to grow its way to profitability.
While we can certainly appreciate Delta 9 Cannabis's revenue growth, its earnings before interest and tax (EBIT) loss is not ideal. Indeed, it lost CA$2.7m at the EBIT level. 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. Another cause for caution is that is bled CA$4.3m in negative free cash flow over the last twelve months. So suffice it to say we consider the stock very risky. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. These risks can be hard to spot. Every company has them, and we've spotted 3 warning signs for Delta 9 Cannabis you should know about.
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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