Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. We note that Bitfarms Ltd. (CVE:BITF) does have debt on its balance sheet. But is this debt a concern to shareholders?
What Risk Does Debt Bring?
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 usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.
What Is Bitfarms's Debt?
You can click the graphic below for the historical numbers, but it shows that as of March 2020 Bitfarms had US$15.6m of debt, an increase on US$5.55m, over one year. However, because it has a cash reserve of US$2.33m, its net debt is less, at about US$13.3m.
How Strong Is Bitfarms's Balance Sheet?
The latest balance sheet data shows that Bitfarms had liabilities of US$7.19m due within a year, and liabilities of US$16.6m falling due after that. Offsetting these obligations, it had cash of US$2.33m as well as receivables valued at US$3.14m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$18.3m.
While this might seem like a lot, it is not so bad since Bitfarms has a market capitalization of US$30.6m, and so it could probably strengthen its balance sheet by raising capital if it needed to. However, it is still worthwhile taking a close look at its ability to pay off debt.
We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.
While Bitfarms has a quite reasonable net debt to EBITDA multiple of 1.6, its interest cover seems weak, at 0.34. In large part that's it has so much depreciation and amortisation. While companies often boast that these charges are non-cash, most such businesses will therefore require ongoing investment (that is not expensed.) In any case, it's safe to say the company has meaningful debt. We also note that Bitfarms improved its EBIT from a last year's loss to a positive US$1.3m. There's no doubt that we learn most about debt from the balance sheet. But it is Bitfarms'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.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So it's worth checking how much of the earnings before interest and tax (EBIT) is backed by free cash flow. During the last year, Bitfarms burned a lot of cash. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.
On the face of it, Bitfarms's interest cover left us tentative about the stock, and its conversion of EBIT to free cash flow was no more enticing than the one empty restaurant on the busiest night of the year. But at least it's pretty decent at managing its debt, based on its EBITDA,; that's encouraging. Overall, we think it's fair to say that Bitfarms has enough debt that there are some real risks around the balance sheet. If everything goes well that may pay off but the downside of this debt is a greater risk of permanent losses. 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. For instance, we've identified 5 warning signs for Bitfarms (2 are a bit unpleasant) you should be aware of.
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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