Is Hexagon Composites (OB:HEX) Using Too Much Debt?

Legendary fund manager Li Lu (who Charlie Munger backed) once said, '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. We note that Hexagon Composites ASA (OB:HEX) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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.

View our latest analysis for Hexagon Composites

What Is Hexagon Composites's Net Debt?

As you can see below, at the end of June 2022, Hexagon Composites had kr1.90b of debt, up from kr1.11b a year ago. Click the image for more detail. However, because it has a cash reserve of kr803.7m, its net debt is less, at about kr1.10b.

How Healthy Is Hexagon Composites' Balance Sheet?

We can see from the most recent balance sheet that Hexagon Composites had liabilities of kr1.60b falling due within a year, and liabilities of kr2.41b due beyond that. Offsetting this, it had kr803.7m in cash and kr926.6m in receivables that were due within 12 months. So its liabilities total kr2.28b more than the combination of its cash and short-term receivables.

While this might seem like a lot, it is not so bad since Hexagon Composites has a market capitalization of kr4.64b, and so it could probably strengthen its balance sheet by raising capital if it needed to. However, it is still worthwhile taking a close look at its ability to pay off debt. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Hexagon Composites can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Over 12 months, Hexagon Composites reported revenue of kr4.3b, which is a gain of 39%, although it did not report any earnings before interest and tax. With any luck the company will be able to grow its way to profitability.

Caveat Emptor

While we can certainly appreciate Hexagon Composites's revenue growth, its earnings before interest and tax (EBIT) loss is not ideal. To be specific the EBIT loss came in at kr229m. 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. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. However, it doesn't help that it burned through kr833m of cash over the last year. So suffice it to say we consider the stock very risky. For riskier companies like Hexagon Composites I always like to keep an eye on whether insiders are buying or selling. So click here if you want to find out for yourself.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.