Is TeraGo (TSE:TGO) Using Debt In A Risky Way?

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says '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 TeraGo Inc. (TSE:TGO) makes use of debt. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for TeraGo

What Is TeraGo's Debt?

The image below, which you can click on for greater detail, shows that at June 2023 TeraGo had debt of CA$12.9m, up from none in one year. However, because it has a cash reserve of CA$5.07m, its net debt is less, at about CA$7.79m.

A Look At TeraGo's Liabilities

We can see from the most recent balance sheet that TeraGo had liabilities of CA$8.58m falling due within a year, and liabilities of CA$23.0m due beyond that. Offsetting these obligations, it had cash of CA$5.07m as well as receivables valued at CA$1.92m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CA$24.6m.

This deficit is considerable relative to its market capitalization of CA$29.5m, so it does suggest shareholders should keep an eye on TeraGo's use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine TeraGo's ability to maintain a healthy balance sheet going forward. 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 TeraGo had a loss before interest and tax, and actually shrunk its revenue by 28%, to CA$26m. That makes us nervous, to say the least.

Caveat Emptor

Not only did TeraGo's revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). Indeed, it lost a very considerable CA$9.0m at the EBIT level. When we look at that and recall the liabilities on its balance sheet, relative to cash, it seems unwise to us for the company to have any debt. So we think its balance sheet is a little strained, though not beyond repair. Another cause for caution is that is bled CA$6.6m in negative free cash flow over the last twelve months. 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. To that end, you should learn about the 4 warning signs we've spotted with TeraGo (including 1 which is potentially serious) .

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.