Is Flotek Industries (NYSE:FTK) A Risky Investment?

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says '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 note that Flotek Industries, Inc. (NYSE:FTK) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Flotek Industries

How Much Debt Does Flotek Industries Carry?

As you can see below, at the end of December 2020, Flotek Industries had US$5.67m of debt, up from none a year ago. Click the image for more detail. However, it does have US$38.7m in cash offsetting this, leading to net cash of US$33.0m.

How Healthy Is Flotek Industries' Balance Sheet?

The latest balance sheet data shows that Flotek Industries had liabilities of US$28.9m due within a year, and liabilities of US$10.2m falling due after that. Offsetting these obligations, it had cash of US$38.7m as well as receivables valued at US$12.2m due within 12 months. So it can boast US$11.8m more liquid assets than total liabilities.

This short term liquidity is a sign that Flotek Industries could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that Flotek Industries has more cash than debt is arguably a good indication that it can manage its debt safely. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Flotek Industries 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.

In the last year Flotek Industries had a loss before interest and tax, and actually shrunk its revenue by 55%, to US$53m. That makes us nervous, to say the least.

So How Risky Is Flotek Industries?

Statistically speaking companies that lose money are riskier than those that make money. And the fact is that over the last twelve months Flotek 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$49m and booked a US$136m accounting loss. While this does make the company a bit risky, it's important to remember it has net cash of US$33.0m. 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. Case in point: We've spotted 4 warning signs for Flotek Industries you should be aware of, and 2 of them shouldn't be ignored.

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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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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