Is Ellies Holdings (JSE:ELI) Using Too Much 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.' 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 Ellies Holdings Limited (JSE:ELI) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. If things get really bad, the lenders can take control of the business. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Ellies Holdings

How Much Debt Does Ellies Holdings Carry?

You can click the graphic below for the historical numbers, but it shows that Ellies Holdings had R191.4m of debt in October 2020, down from R199.4m, one year before. However, it does have R8.43m in cash offsetting this, leading to net debt of about R182.9m.

How Healthy Is Ellies Holdings's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Ellies Holdings had liabilities of R291.5m due within 12 months and liabilities of R146.2m due beyond that. Offsetting these obligations, it had cash of R8.43m as well as receivables valued at R225.5m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by R203.8m.

This deficit casts a shadow over the R68.2m company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. After all, Ellies Holdings would likely require a major re-capitalisation if it had to pay its creditors today. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Ellies Holdings'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.

In the last year Ellies Holdings had a loss before interest and tax, and actually shrunk its revenue by 12%, to R1.2b. That's not what we would hope to see.

Caveat Emptor

Not only did Ellies Holdings's revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). Its EBIT loss was a whopping R56m. Combining this information with the significant liabilities we already touched on makes us very hesitant about this stock, to say the least. Of course, it may be able to improve its situation with a bit of luck and good execution. But we think that is unlikely since it is low on liquid assets, and made a loss of R138m in the last year. So we think this stock is quite risky. We'd prefer to pass. 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. Be aware that Ellies Holdings is showing 3 warning signs in our investment analysis , and 2 of those make us 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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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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