These 4 Measures Indicate That Urbanimmersive (CVE:UI) Is Using Debt Extensively

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. Importantly, Urbanimmersive Inc. (CVE:UI) does carry debt. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. If things get really bad, the lenders can take control of the business. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Urbanimmersive

What Is Urbanimmersive's Net Debt?

The image below, which you can click on for greater detail, shows that at September 2020 Urbanimmersive had debt of CA$4.99m, up from CA$3.73m in one year. On the flip side, it has CA$884.6k in cash leading to net debt of about CA$4.10m.

How Strong Is Urbanimmersive's Balance Sheet?

The latest balance sheet data shows that Urbanimmersive had liabilities of CA$1.28m due within a year, and liabilities of CA$5.36m falling due after that. Offsetting this, it had CA$884.6k in cash and CA$93.9k in receivables that were due within 12 months. So its liabilities total CA$5.67m more than the combination of its cash and short-term receivables.

This deficit isn't so bad because Urbanimmersive is worth CA$21.7m, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Weak interest cover of 0.41 times and a disturbingly high net debt to EBITDA ratio of 5.1 hit our confidence in Urbanimmersive like a one-two punch to the gut. The debt burden here is substantial. Looking on the bright side, Urbanimmersive boosted its EBIT by a silky 44% in the last year. Like the milk of human kindness that sort of growth increases resilience, making the company more capable of managing debt. There's no doubt that we learn most about debt from the balance sheet. But it is Urbanimmersive's earnings that will influence how the balance sheet holds up in the future. 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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Considering the last two years, Urbanimmersive actually recorded a cash outflow, overall. Debt is far more risky for companies with unreliable free cash flow, so shareholders should be hoping that the past expenditure will produce free cash flow in the future.

Our View

Neither Urbanimmersive's ability to cover its interest expense with its EBIT nor its conversion of EBIT to free cash flow gave us confidence in its ability to take on more debt. But the good news is it seems to be able to grow its EBIT with ease. When we consider all the factors discussed, it seems to us that Urbanimmersive is taking some risks with its use of debt. So while that leverage does boost returns on equity, we wouldn't really want to see it increase from here. 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. For example - Urbanimmersive has 4 warning signs we think you should be aware of.

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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