Health Check: How Prudently Does Rocky Mountain Chocolate Factory (NASDAQ:RMCF) Use 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.' 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 Rocky Mountain Chocolate Factory, Inc. (NASDAQ:RMCF) does use debt in its business. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for Rocky Mountain Chocolate Factory

How Much Debt Does Rocky Mountain Chocolate Factory Carry?

As you can see below, at the end of November 2020, Rocky Mountain Chocolate Factory had US$4.89m of debt, up from US$127.6k a year ago. Click the image for more detail. But on the other hand it also has US$7.27m in cash, leading to a US$2.38m net cash position.

How Healthy Is Rocky Mountain Chocolate Factory's Balance Sheet?

We can see from the most recent balance sheet that Rocky Mountain Chocolate Factory had liabilities of US$8.76m falling due within a year, and liabilities of US$2.84m due beyond that. On the other hand, it had cash of US$7.27m and US$2.85m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$1.47m.

Of course, Rocky Mountain Chocolate Factory has a market capitalization of US$26.5m, so these liabilities are probably manageable. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. Despite its noteworthy liabilities, Rocky Mountain Chocolate Factory 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 you can't view debt in total isolation; since Rocky Mountain Chocolate Factory will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Over 12 months, Rocky Mountain Chocolate Factory made a loss at the EBIT level, and saw its revenue drop to US$23m, which is a fall of 29%. To be frank that doesn't bode well.

So How Risky Is Rocky Mountain Chocolate Factory?

We have no doubt that loss making companies are, in general, riskier than profitable ones. And we do note that Rocky Mountain Chocolate Factory had an earnings before interest and tax (EBIT) loss, over the last year. And over the same period it saw negative free cash outflow of US$2.0m and booked a US$3.6m accounting loss. With only US$2.38m on the balance sheet, it would appear that its going to need to raise capital again soon. Overall, we'd say the stock is a bit risky, and we're usually very cautious until we see positive free cash flow. 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 example Rocky Mountain Chocolate Factory has 3 warning signs (and 1 which doesn't sit too well with us) we think you should know about.

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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