Is Loop Industries (NASDAQ:LOOP) Using Debt Sensibly?

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.' 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. We can see that Loop Industries, Inc. (NASDAQ:LOOP) does use debt in its business. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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 thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Loop Industries

How Much Debt Does Loop Industries Carry?

The image below, which you can click on for greater detail, shows that at November 2021 Loop Industries had debt of US$4.20m, up from US$2.39m in one year. But it also has US$55.0m in cash to offset that, meaning it has US$50.8m net cash.

How Strong Is Loop Industries' Balance Sheet?

The latest balance sheet data shows that Loop Industries had liabilities of US$6.31m due within a year, and liabilities of US$3.32m falling due after that. On the other hand, it had cash of US$55.0m and US$825.4k worth of receivables due within a year. So it actually has US$46.2m more liquid assets than total liabilities.

This surplus suggests that Loop Industries has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Loop Industries has more cash than debt is arguably a good indication that it can manage its debt safely. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Loop Industries'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.

Given it has no significant operating revenue at the moment, shareholders will be hoping Loop Industries can make progress and gain better traction for the business, before it runs low on cash.

So How Risky Is Loop Industries?

We have no doubt that loss making companies are, in general, riskier than profitable ones. And the fact is that over the last twelve months Loop Industries lost money at the earnings before interest and tax (EBIT) line. And over the same period it saw negative free cash outflow of US$47m and booked a US$44m accounting loss. While this does make the company a bit risky, it's important to remember it has net cash of US$50.8m. That means it could keep spending at its current rate for more than two years. Overall, its balance sheet doesn't seem overly risky, at the moment, but we're always cautious until we see the 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. We've identified 5 warning signs with Loop Industries (at least 2 which shouldn't be ignored) , and understanding them should be part of your investment process.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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.