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

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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 Fire & Flower Holdings Corp. (TSE:FAF) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

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. 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. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Fire & Flower Holdings

What Is Fire & Flower Holdings's Debt?

As you can see below, Fire & Flower Holdings had CA$13.5m of debt at December 2022, down from CA$21.8m a year prior. However, because it has a cash reserve of CA$12.4m, its net debt is less, at about CA$1.09m.

How Strong Is Fire & Flower Holdings' Balance Sheet?

The latest balance sheet data shows that Fire & Flower Holdings had liabilities of CA$52.4m due within a year, and liabilities of CA$39.9m falling due after that. Offsetting these obligations, it had cash of CA$12.4m as well as receivables valued at CA$15.5m due within 12 months. So it has liabilities totalling CA$64.4m more than its cash and near-term receivables, combined.

Given this deficit is actually higher than the company's market capitalization of CA$50.1m, we think shareholders really should watch Fire & Flower Holdings's debt levels, like a parent watching their child ride a bike for the first time. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer extensive dilution. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Fire & Flower Holdings can strengthen its balance sheet over time. 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 Fire & Flower Holdings had a loss before interest and tax, and actually shrunk its revenue by 3.1%, to CA$170m. We would much prefer see growth.

Caveat Emptor

Importantly, Fire & Flower Holdings had an earnings before interest and tax (EBIT) loss over the last year. Its EBIT loss was a whopping CA$40m. When we look at that alongside the significant liabilities, we're not particularly confident about the company. It would need to improve its operations quickly for us to be interested in it. Not least because it had negative free cash flow of CA$22m over the last twelve months. That means it's on the risky side of things. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 4 warning signs for Fire & Flower Holdings (1 doesn't sit too well with us) you should be aware of.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.