Chrometco (JSE:CMO) Has Debt But No Earnings; Should You Worry?

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. As with many other companies Chrometco Limited (JSE:CMO) makes use of debt. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Chrometco

What Is Chrometco's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of February 2021 Chrometco had R491.2m of debt, an increase on R461.9m, over one year. And it doesn't have much cash, so its net debt is about the same.

A Look At Chrometco's Liabilities

The latest balance sheet data shows that Chrometco had liabilities of R994.1m due within a year, and liabilities of R422.3m falling due after that. Offsetting this, it had R1.79m in cash and R109.8m in receivables that were due within 12 months. So its liabilities total R1.30b more than the combination of its cash and short-term receivables.

The deficiency here weighs heavily on the R178.0m company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we definitely think shareholders need to watch this one closely. After all, Chrometco would likely require a major re-capitalisation if it had to pay its creditors today. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Chrometco will need earnings to service that debt. 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.

In the last year Chrometco wasn't profitable at an EBIT level, but managed to grow its revenue by 25%, to R1.4b. Shareholders probably have their fingers crossed that it can grow its way to profits.

Caveat Emptor

While we can certainly appreciate Chrometco's revenue growth, its earnings before interest and tax (EBIT) loss is not ideal. Indeed, it lost a very considerable R334m at the EBIT level. Reflecting on this and the significant total liabilities, it's hard to know what to say about the stock because of our intense dis-affinity for it. Sure, the company might have a nice story about how they are going on to a brighter future. But the reality is that it is low on liquid assets relative to liabilities, and it lost R98m in the last year. So we're not very excited about owning this stock. Its too risky for us. 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 2 warning signs with Chrometco , 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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