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 Art’s-Way Manufacturing Co., Inc. (NASDAQ:ARTW) does have debt on its balance sheet. But should shareholders be worried about its use of debt?
Why Does Debt Bring Risk?
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. Ultimately, if the company can’t fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest 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 Art’s-Way Manufacturing’s Debt?
The image below, which you can click on for greater detail, shows that Art’s-Way Manufacturing had debt of US$5.01m at the end of November 2019, a reduction from US$6.26m over a year. Net debt is about the same, since the it doesn’t have much cash.
A Look At Art’s-Way Manufacturing’s Liabilities
Zooming in on the latest balance sheet data, we can see that Art’s-Way Manufacturing had liabilities of US$5.20m due within 12 months and liabilities of US$2.35m due beyond that. Offsetting these obligations, it had cash of US$3.1k as well as receivables valued at US$2.55m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$5.00m.
Art’s-Way Manufacturing has a market capitalization of US$9.35m, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt. When analysing debt levels, the balance sheet is the obvious place to start. 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.
In the last year Art’s-Way Manufacturing wasn’t profitable at an EBIT level, but managed to grow its revenue by 16%, to US$23m. That rate of growth is a bit slow for our taste, but it takes all types to make a world.
Importantly, Art’s-Way Manufacturing had negative earnings before interest and tax (EBIT), over the last year. Indeed, it lost a very considerable US$1.5m 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. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. We would feel better if it turned its trailing twelve month loss of US$1.4m into a profit. So to be blunt we do think it is risky. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet – far from it. For example, we’ve discovered 3 warning signs for Art’s-Way Manufacturing (2 can’t be ignored!) that you should be aware of before investing here.
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.
If you spot an error that warrants correction, please contact the editor at email@example.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned.
We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Thank you for reading.