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 note that High Tide Inc. (CVE:HITI) does have debt on its balance sheet. But should shareholders be worried about its use of debt?
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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.
How Much Debt Does High Tide Carry?
The image below, which you can click on for greater detail, shows that at July 2022 High Tide had debt of CA$30.3m, up from CA$25.9m in one year. However, it does have CA$18.7m in cash offsetting this, leading to net debt of about CA$11.6m.
How Healthy Is High Tide's Balance Sheet?
We can see from the most recent balance sheet that High Tide had liabilities of CA$52.2m falling due within a year, and liabilities of CA$54.9m due beyond that. Offsetting this, it had CA$18.7m in cash and CA$14.1m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CA$74.3m.
While this might seem like a lot, it is not so bad since High Tide has a market capitalization of CA$155.4m, and so it could probably strengthen its balance sheet by raising capital if it needed to. But it's clear that we should definitely closely examine whether it can manage its debt without dilution. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine High Tide'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 High Tide wasn't profitable at an EBIT level, but managed to grow its revenue by 99%, to CA$302m. Shareholders probably have their fingers crossed that it can grow its way to profits.
While we can certainly appreciate High Tide's revenue growth, its earnings before interest and tax (EBIT) loss is not ideal. Its EBIT loss was a whopping CA$18m. When we look at that and recall the liabilities on its balance sheet, relative to cash, it seems unwise to us for the company to have any 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$11m 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. However, not all investment risk resides within the balance sheet - far from it. To that end, you should be aware of the 2 warning signs we've spotted with High Tide .
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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Find out whether High Tide is potentially over or undervalued by checking out our comprehensive analysis, which includes fair value estimates, risks and warnings, dividends, insider transactions and financial health.View the Free Analysis
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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.