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 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 Hydro66 Holdings Corp. (CSE:SIX) makes use of debt. But should shareholders be worried about its use of debt?
When Is Debt Dangerous?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. 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. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest 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 Hydro66 Holdings
How Much Debt Does Hydro66 Holdings Carry?
The image below, which you can click on for greater detail, shows that at September 2020 Hydro66 Holdings had debt of CA$5.32m, up from CA$2.73m in one year. On the flip side, it has CA$621.2k in cash leading to net debt of about CA$4.69m.
A Look At Hydro66 Holdings's Liabilities
According to the last reported balance sheet, Hydro66 Holdings had liabilities of CA$2.74m due within 12 months, and liabilities of CA$6.75m due beyond 12 months. Offsetting these obligations, it had cash of CA$621.2k as well as receivables valued at CA$411.1k due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CA$8.46m.
Hydro66 Holdings has a market capitalization of CA$35.9m, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Hydro66 Holdings will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.
In the last year Hydro66 Holdings had a loss before interest and tax, and actually shrunk its revenue by 35%, to CA$3.4m. To be frank that doesn't bode well.
Caveat Emptor
While Hydro66 Holdings's falling revenue is about as heartwarming as a wet blanket, arguably its earnings before interest and tax (EBIT) loss is even less appealing. Indeed, it lost a very considerable CA$4.4m at the EBIT level. Considering that alongside the liabilities mentioned above does not give us much confidence that company should be using so much debt. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. However, it doesn't help that it burned through CA$3.1m of cash over the last year. 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. Be aware that Hydro66 Holdings is showing 5 warning signs in our investment analysis , and 2 of those shouldn't be ignored...
If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.
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This article by Simply Wall St is general in nature. 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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About CNSX:SIX
Moderate with mediocre balance sheet.
