Is Fire & Flower Holdings (TSE:FAF) Using Debt Sensibly?

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.' 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. We can see that Fire & Flower Holdings Corp. (TSE:FAF) does use debt in its business. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

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. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Fire & Flower Holdings

What Is Fire & Flower Holdings's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of October 2022 Fire & Flower Holdings had CA$13.2m of debt, an increase on CA$1.70m, over one year. But it also has CA$17.3m in cash to offset that, meaning it has CA$4.16m net cash.

A Look At Fire & Flower Holdings' Liabilities

The latest balance sheet data shows that Fire & Flower Holdings had liabilities of CA$36.9m due within a year, and liabilities of CA$55.5m falling due after that. Offsetting this, it had CA$17.3m in cash and CA$16.2m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CA$58.9m.

When you consider that this deficiency exceeds the company's CA$54.6m market capitalization, you might well be inclined to review the balance sheet intently. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price. Fire & Flower Holdings boasts net cash, so it's fair to say it does not have a heavy debt load, even if it does have very significant liabilities, in total. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Fire & Flower Holdings can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Over 12 months, Fire & Flower Holdings made a loss at the EBIT level, and saw its revenue drop to CA$168m, which is a fall of 4.4%. We would much prefer see growth.

So How Risky Is Fire & Flower Holdings?

By their very nature companies that are losing money are more risky than those with a long history of profitability. And we do note that Fire & Flower Holdings had an earnings before interest and tax (EBIT) loss, over the last year. And over the same period it saw negative free cash outflow of CA$26m and booked a CA$79m accounting loss. Given it only has net cash of CA$4.16m, the company may need to raise more capital if it doesn't reach break-even soon. Summing up, we're a little skeptical of this one, as it seems fairly risky in the absence of free cashflow. 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. We've identified 4 warning signs with Fire & Flower Holdings (at least 1 which is potentially serious) , and understanding them should be part of your investment process.

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.