David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' 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 can see that Rocky Mountain Chocolate Factory, Inc. (NASDAQ:RMCF) does use debt in its business. But should shareholders be worried about its use of debt?
When Is Debt Dangerous?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.
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. However, it does have US$7.27m in cash offsetting this, leading to net cash of US$2.38m.
A Look At Rocky Mountain Chocolate Factory's Liabilities
According to the last reported balance sheet, Rocky Mountain Chocolate Factory had liabilities of US$8.76m due within 12 months, and liabilities of US$2.84m due beyond 12 months. 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 total US$1.47m more than the combination of its cash and short-term receivables.
Given Rocky Mountain Chocolate Factory has a market capitalization of US$37.1m, it's hard to believe these liabilities pose much threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. While it does have liabilities worth noting, Rocky Mountain Chocolate Factory also has more cash than debt, so we're pretty confident it can manage its debt safely. There's no doubt that we learn most about debt from the balance sheet. But it is Rocky Mountain Chocolate Factory'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, 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 in the last year Rocky Mountain Chocolate Factory had an earnings before interest and tax (EBIT) loss, truth be told. Indeed, in that time it burnt through US$2.0m of cash and made a loss of US$3.6m. Given it only has net cash of US$2.38m, the company may need to raise more capital if it doesn't reach break-even soon. Overall, we'd say the stock is a bit risky, and we're usually very cautious until we see positive free cash flow. 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. To that end, you should learn about the 3 warning signs we've spotted with Rocky Mountain Chocolate Factory (including 1 which makes us a bit uncomfortable) .
If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.
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