Is Emergia (CSE:EMER) Using Debt In A Risky Way?

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.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. As with many other companies Emergia Inc. (CSE:EMER) makes use of debt. But is this debt a concern to shareholders?

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 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.

See our latest analysis for Emergia

What Is Emergia's Debt?

You can click the graphic below for the historical numbers, but it shows that Emergia had CA$49.1m of debt in September 2021, down from CA$60.9m, one year before. Net debt is about the same, since the it doesn't have much cash.

How Strong Is Emergia's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Emergia had liabilities of CA$16.4m due within 12 months and liabilities of CA$39.3m due beyond that. Offsetting these obligations, it had cash of CA$36.0k as well as receivables valued at CA$34.0k due within 12 months. So it has liabilities totalling CA$55.6m more than its cash and near-term receivables, combined.

This deficit casts a shadow over the CA$33.9m company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. At the end of the day, Emergia would probably need a major re-capitalization if its creditors were to demand repayment. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Emergia'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.

Over 12 months, Emergia made a loss at the EBIT level, and saw its revenue drop to CA$934k, which is a fall of 68%. To be frank that doesn't bode well.

Caveat Emptor

Not only did Emergia's revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). Indeed, it lost CA$2.4m at the EBIT level. Considering that alongside the liabilities mentioned above make us nervous about the company. It would need to improve its operations quickly for us to be interested in it. It's fair to say the loss of CA$22m didn't encourage us either; we'd like to see a profit. And until that time we think this is a risky stock. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. These risks can be hard to spot. Every company has them, and we've spotted 4 warning signs for Emergia (of which 3 are concerning!) 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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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.