Decibel Cannabis (CVE:DB) Has Debt But No Earnings; Should You Worry?

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. We can see that Decibel Cannabis Company Inc. (CVE:DB) does use debt in its business. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

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 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. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out the opportunities and risks within the CA Pharmaceuticals industry.

How Much Debt Does Decibel Cannabis Carry?

The chart below, which you can click on for greater detail, shows that Decibel Cannabis had CA$44.9m in debt in June 2022; about the same as the year before. However, it does have CA$3.13m in cash offsetting this, leading to net debt of about CA$41.8m.

How Healthy Is Decibel Cannabis' Balance Sheet?

We can see from the most recent balance sheet that Decibel Cannabis had liabilities of CA$45.5m falling due within a year, and liabilities of CA$40.3m due beyond that. Offsetting this, it had CA$3.13m in cash and CA$15.8m in receivables that were due within 12 months. So its liabilities total CA$66.9m more than the combination of its cash and short-term receivables.

The deficiency here weighs heavily on the CA$26.3m company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we definitely think shareholders need to watch this one closely. At the end of the day, Decibel Cannabis would probably need a major re-capitalization if its creditors were to demand repayment. 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 Decibel Cannabis's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

In the last year Decibel Cannabis wasn't profitable at an EBIT level, but managed to grow its revenue by 42%, to CA$63m. With any luck the company will be able to grow its way to profitability.

Caveat Emptor

Even though Decibel Cannabis managed to grow its top line quite deftly, the cold hard truth is that it is losing money on the EBIT line. Indeed, it lost CA$1.6m at the EBIT level. If you consider the significant liabilities mentioned above, we are extremely wary of this investment. Of course, it may be able to improve its situation with a bit of luck and good execution. Nevertheless, we would not bet on it given that it vaporized CA$11m in cash over the last twelve months, and it doesn't have much by way of liquid assets. So we think this stock is risky, like walking through a dirty dog park with a mask on. 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. To that end, you should learn about the 2 warning signs we've spotted with Decibel Cannabis (including 1 which is significant) .

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.