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.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. As with many other companies XTM Inc. (CSE:PAID) makes use of debt. But the more important question is: how much risk is that debt creating?
When Is Debt Dangerous?
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. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.
How Much Debt Does XTM Carry?
As you can see below, at the end of June 2021, XTM had CA$2.12m of debt, up from CA$549.6k a year ago. Click the image for more detail. But it also has CA$3.91m in cash to offset that, meaning it has CA$1.80m net cash.
A Look At XTM's Liabilities
We can see from the most recent balance sheet that XTM had liabilities of CA$13.7m falling due within a year, and liabilities of CA$52.7k due beyond that. Offsetting these obligations, it had cash of CA$3.91m as well as receivables valued at CA$554.9k due within 12 months. So its liabilities total CA$9.32m more than the combination of its cash and short-term receivables.
Since publicly traded XTM shares are worth a total of CA$54.4m, it seems unlikely that this level of liabilities would be a major threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. While it does have liabilities worth noting, XTM also has more cash than debt, so we're pretty confident it can manage its debt safely. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since XTM will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.
In the last year XTM wasn't profitable at an EBIT level, but managed to grow its revenue by 33%, to CA$1.1m. With any luck the company will be able to grow its way to profitability.
So How Risky Is XTM?
We have no doubt that loss making companies are, in general, riskier than profitable ones. And we do note that XTM had an earnings before interest and tax (EBIT) loss, over the last year. Indeed, in that time it burnt through CA$2.8m of cash and made a loss of CA$4.2m. Given it only has net cash of CA$1.80m, the company may need to raise more capital if it doesn't reach break-even soon. With very solid revenue growth in the last year, XTM may be on a path to profitability. Pre-profit companies are often risky, but they can also offer great rewards. 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. For example XTM has 5 warning signs (and 3 which shouldn't be ignored) we think you should know about.
If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.
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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.
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