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. We note that Pelatro Plc (LON:PTRO) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.
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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.
What Is Pelatro's Debt?
As you can see below, at the end of June 2021, Pelatro had US$1.54m of debt, up from US$1.29m a year ago. Click the image for more detail. However, it also had US$784.0k in cash, and so its net debt is US$751.0k.
How Strong Is Pelatro's Balance Sheet?
We can see from the most recent balance sheet that Pelatro had liabilities of US$1.49m falling due within a year, and liabilities of US$1.44m due beyond that. Offsetting these obligations, it had cash of US$784.0k as well as receivables valued at US$4.45m due within 12 months. So it can boast US$2.31m more liquid assets than total liabilities.
This short term liquidity is a sign that Pelatro could probably pay off its debt with ease, as its balance sheet is far from stretched. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Pelatro can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.
Over 12 months, Pelatro made a loss at the EBIT level, and saw its revenue drop to US$5.2m, which is a fall of 17%. That's not what we would hope to see.
Not only did Pelatro's revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). To be specific the EBIT loss came in at US$1.2m. On a more positive note, the company does have liquid assets, so it has a bit of time to improve its operations before the debt becomes an acute problem. But we'd want to see some positive free cashflow before spending much time on trying to understand the stock. So it seems too risky for our taste. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. We've identified 2 warning signs with Pelatro , and understanding them should be part of your investment process.
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.
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.
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