Would Maxim Power (TSE:MXG) Be Better Off With Less Debt?

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.' 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 Maxim Power Corp. (TSE:MXG) makes use of debt. But the real question is whether this debt is making the company risky.

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 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, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Maxim Power

How Much Debt Does Maxim Power Carry?

The image below, which you can click on for greater detail, shows that at September 2020 Maxim Power had debt of CA$66.3m, up from none in one year. However, because it has a cash reserve of CA$5.77m, its net debt is less, at about CA$60.5m.

How Strong Is Maxim Power's Balance Sheet?

The latest balance sheet data shows that Maxim Power had liabilities of CA$12.3m due within a year, and liabilities of CA$84.7m falling due after that. Offsetting this, it had CA$5.77m in cash and CA$5.47m in receivables that were due within 12 months. So it has liabilities totalling CA$85.8m more than its cash and near-term receivables, combined.

This is a mountain of leverage relative to its market capitalization of CA$119.5m. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Maxim Power 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.

Over 12 months, Maxim Power reported revenue of CA$34m, which is a gain of 4.1%, although it did not report any earnings before interest and tax. That rate of growth is a bit slow for our taste, but it takes all types to make a world.

Caveat Emptor

Importantly, Maxim Power had an earnings before interest and tax (EBIT) loss over the last year. Indeed, it lost CA$1.6m 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$59m in negative free cash flow over the last twelve months. So suffice it to say we consider the stock very risky. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For example Maxim Power has 2 warning signs (and 1 which makes us a bit uncomfortable) we think you should know about.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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