Auditors Have Doubts About ZOO Digital Group (LON:ZOO)

Unfortunately for shareholders, when ZOO Digital Group plc (LON:ZOO) reported results for the period to March 2021, its auditors, Grant Thornton, expressed uncertainty about whether it can continue as a going concern. This means that, based on the financial results to that date, the company arguably should raise capital, or otherwise strengthen the balance sheet, as soon as possible.

If the company does have to issue more shares, potential investors will be sure to consider how desperate it is for capital. So it is suddenly extremely important to consider whether the company is taking too much risk on its balance sheet. The biggest concern we would have is the company's debt, since its lenders might force the company into administration if it cannot repay them.

View our latest analysis for ZOO Digital Group

How Much Debt Does ZOO Digital Group Carry?

As you can see below, ZOO Digital Group had US$3.53m of debt, at March 2021, which is about the same as the year before. You can click the chart for greater detail. On the flip side, it has US$2.95m in cash leading to net debt of about US$577.0k.

How Healthy Is ZOO Digital Group's Balance Sheet?

According to the last reported balance sheet, ZOO Digital Group had liabilities of US$20.3m due within 12 months, and liabilities of US$1.76m due beyond 12 months. On the other hand, it had cash of US$2.95m and US$9.56m worth of receivables due within a year. So its liabilities total US$9.50m more than the combination of its cash and short-term receivables.

Since publicly traded ZOO Digital Group shares are worth a total of US$136.3m, it seems unlikely that this level of liabilities would be a major threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. Carrying virtually no net debt, ZOO Digital Group has a very light debt load indeed.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

ZOO Digital Group has a very low debt to EBITDA ratio of 0.21 so it is strange to see weak interest coverage, with last year's EBIT being only 1.4 times the interest expense. So while we're not necessarily alarmed we think that its debt is far from trivial. We also note that ZOO Digital Group improved its EBIT from a last year's loss to a positive US$962k. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine ZOO Digital Group'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.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it's worth checking how much of the earnings before interest and tax (EBIT) is backed by free cash flow. Happily for any shareholders, ZOO Digital Group actually produced more free cash flow than EBIT over the last year. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Our View

The good news is that ZOO Digital Group's demonstrated ability to convert EBIT to free cash flow delights us like a fluffy puppy does a toddler. But we must concede we find its interest cover has the opposite effect. All these things considered, it appears that ZOO Digital Group can comfortably handle its current debt levels. On the plus side, this leverage can boost shareholder returns, but the potential downside is more risk of loss, so it's worth monitoring the balance sheet. While some investors may specialize in these sort of situations, it's simply too risky and complicated for us to want to invest in a company after an auditor has expressed doubts about its ability to continue as a going concern. We prefer to invest in companies that ensure the balance sheet remains healthier than that. 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 1 warning sign for ZOO Digital Group that you should be aware of.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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