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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We can see that Fuel Tech, Inc. (NASDAQ:FTEK) does use debt in its business. But should shareholders be worried about its use of debt?
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. 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. When we think about a company's use of debt, we first look at cash and debt together.
What Is Fuel Tech's Debt?
The image below, which you can click on for greater detail, shows that at June 2020 Fuel Tech had debt of US$1.56m, up from none in one year. But it also has US$8.25m in cash to offset that, meaning it has US$6.70m net cash.
How Strong Is Fuel Tech's Balance Sheet?
The latest balance sheet data shows that Fuel Tech had liabilities of US$5.37m due within a year, and liabilities of US$2.06m falling due after that. Offsetting this, it had US$8.25m in cash and US$5.73m in receivables that were due within 12 months. So it actually has US$6.55m more liquid assets than total liabilities.
This luscious liquidity implies that Fuel Tech's balance sheet is sturdy like a giant sequoia tree. Having regard to this fact, we think its balance sheet is just as strong as misogynists are weak. Succinctly put, Fuel Tech boasts net cash, so it's fair to say it does not have a heavy debt load! There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Fuel Tech's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.
In the last year Fuel Tech had a loss before interest and tax, and actually shrunk its revenue by 62%, to US$20m. That makes us nervous, to say the least.
So How Risky Is Fuel Tech?
We have no doubt that loss making companies are, in general, riskier than profitable ones. And in the last year Fuel Tech had an earnings before interest and tax (EBIT) loss, truth be told. Indeed, in that time it burnt through US$4.3m of cash and made a loss of US$11m. While this does make the company a bit risky, it's important to remember it has net cash of US$6.70m. That means it could keep spending at its current rate for more than two years. Even though its balance sheet seems sufficiently liquid, debt always makes us a little nervous if a company doesn't produce free cash flow regularly. 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. Consider for instance, the ever-present spectre of investment risk. We've identified 3 warning signs with Fuel Tech , and understanding them should be part of your investment process.
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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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. 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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