Is Auxly Cannabis Group (TSE:XLY) Using Too Much Debt?

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says '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. As with many other companies Auxly Cannabis Group Inc. (TSE:XLY) makes use of debt. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

What Is Auxly Cannabis Group's Net Debt?

The image below, which you can click on for greater detail, shows that Auxly Cannabis Group had debt of CA$54.7m at the end of December 2024, a reduction from CA$123.6m over a year. However, it does have CA$18.5m in cash offsetting this, leading to net debt of about CA$36.2m.

How Strong Is Auxly Cannabis Group's Balance Sheet?

According to the last reported balance sheet, Auxly Cannabis Group had liabilities of CA$123.3m due within 12 months, and liabilities of CA$22.6m due beyond 12 months. On the other hand, it had cash of CA$18.5m and CA$22.6m worth of receivables due within a year. So it has liabilities totalling CA$104.8m more than its cash and near-term receivables, combined.

This is a mountain of leverage relative to its market capitalization of CA$105.2m. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.

See our latest analysis for Auxly Cannabis Group

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

While Auxly Cannabis Group has a quite reasonable net debt to EBITDA multiple of 1.5, its interest cover seems weak, at 0.99. This does have us wondering if the company pays high interest because it is considered risky. Either way there's no doubt the stock is using meaningful leverage. We also note that Auxly Cannabis Group improved its EBIT from a last year's loss to a positive CA$15m. There's no doubt that we learn most about debt from the balance sheet. But it is Auxly Cannabis Group'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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So it's worth checking how much of the earnings before interest and tax (EBIT) is backed by free cash flow. Over the last year, Auxly Cannabis Group recorded free cash flow worth a fulsome 95% of its EBIT, which is stronger than we'd usually expect. That positions it well to pay down debt if desirable to do so.

Our View

Neither Auxly Cannabis Group's ability to cover its interest expense with its EBIT nor its level of total liabilities gave us confidence in its ability to take on more debt. But the good news is it seems to be able to convert EBIT to free cash flow with ease. Looking at all the angles mentioned above, it does seem to us that Auxly Cannabis Group is a somewhat risky investment as a result of its debt. That's not necessarily a bad thing, since leverage can boost returns on equity, but it is something to be aware of. 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 3 warning signs for Auxly Cannabis Group you should be aware of, and 2 of them are significant.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.