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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. Importantly, Art's-Way Manufacturing Co., Inc. (NASDAQ:ARTW) does carry debt. But is this debt a concern to shareholders?
When Is Debt Dangerous?
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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.
What Is Art's-Way Manufacturing's Debt?
The image below, which you can click on for greater detail, shows that at August 2020 Art's-Way Manufacturing had debt of US$5.84m, up from US$5.37m in one year. And it doesn't have much cash, so its net debt is about the same.
How Strong Is Art's-Way Manufacturing's Balance Sheet?
We can see from the most recent balance sheet that Art's-Way Manufacturing had liabilities of US$5.02m falling due within a year, and liabilities of US$4.00m due beyond that. Offsetting these obligations, it had cash of US$4.2k as well as receivables valued at US$1.89m due within 12 months. So it has liabilities totalling US$7.12m more than its cash and near-term receivables, combined.
This deficit is considerable relative to its market capitalization of US$10.7m, so it does suggest shareholders should keep an eye on Art's-Way Manufacturing's use of debt. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Art's-Way Manufacturing's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.
Over 12 months, Art's-Way Manufacturing reported revenue of US$24m, which is a gain of 27%, although it did not report any earnings before interest and tax. Shareholders probably have their fingers crossed that it can grow its way to profits.
Despite the top line growth, Art's-Way Manufacturing still had an earnings before interest and tax (EBIT) loss over the last year. Its EBIT loss was a whopping US$1.8m. 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. Another cause for caution is that is bled US$622k in negative free cash flow over the last twelve months. So suffice it to say we consider the stock very risky. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 4 warning signs for Art's-Way Manufacturing you should be aware of, and 2 of them are a bit unpleasant.
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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Art's-Way Manufacturing Co., Inc. manufactures and sells agricultural equipment, specialized modular science buildings, and steel cutting tools in the United States and internationally.
Acceptable track record with imperfect balance sheet.