Berkshire Hathaway’s Charlie Munger-backed outside fund manager Li Lu is quick to say, “The biggest risk in investing isn’t price volatility, but whether you’re going to suffer a permanent loss of capital “. When we think of a company’s risk, we always like to look at its use of debt, because over-indebtedness can lead to ruin. Above all, Clean Seas Seafood Limited (ASX:CSS) is in debt. But the more important question is: what risk does this debt create?
When is debt a problem?
Debt is a tool to help businesses grow, but if a business is unable to repay its lenders, it exists at their mercy. If things go really bad, lenders can take over the business. However, a more frequent (but still costly) event is when a company has to issue shares at bargain prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, the advantage of debt is that it often represents cheap capital, especially when it replaces dilution in a business with the ability to reinvest at high rates of return. When we look at debt levels, we first consider cash and debt levels, together.
Our analysis indicates that CSS is potentially undervalued!
How much debt does Clean Seas Seafood have?
As you can see below, Clean Seas Seafood had A$5.29 million in debt in June 2022, up from A$20.4 million the previous year. However, he has A$13.0 million in cash to offset this, resulting in a net cash of A$7.69 million.
How healthy is Clean Seas Seafood’s balance sheet?
We can see from the most recent balance sheet that Clean Seas Seafood had liabilities of A$15.3m due within a year, and liabilities of A$3.39m due beyond . In return, he had A$13.0 million in cash and A$5.30 million in receivables due within 12 months. Thus, its liabilities outweigh the sum of its cash and (short-term) receivables of A$435,000.
This indicates that Clean Seas Seafood’s balance sheet looks quite strong, as its total liabilities roughly equal its cash. So while it’s hard to imagine the A$89.4 million company fighting for money, we still think it’s worth keeping an eye on its balance sheet. While it has liabilities to note, Clean Seas Seafood also has more cash than debt, so we’re pretty confident it can manage its debt safely.
Although Clean Seas Seafood posted a loss in EBIT last year, it was also good to see that it generated A$9.1 million in EBIT over the last twelve months. The balance sheet is clearly the area to focus on when analyzing debt. But ultimately, the company’s future profitability will decide whether Clean Seas Seafood can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free analyst earnings forecast report interesting.
Finally, while the taxman may love accounting profits, lenders only accept cash. Although Clean Seas Seafood has net cash on its balance sheet, it’s always worth looking at its ability to convert earnings before interest and taxes (EBIT) to free cash flow, to help us understand how quickly it’s growing. builds (or erodes) cash balance. Over the past year, Clean Seas Seafood has had negative free cash flow, overall. Debt is much riskier for companies with unreliable free cash flow, so shareholders must hope that past spending will produce free cash flow in the future.
While it’s always a good idea to look at a company’s total liabilities, it’s very reassuring that Clean Seas Seafood has A$7.69 million in net cash. We are therefore not concerned about the use of Clean Seas Seafood debt. When analyzing debt levels, the balance sheet is the obvious starting point. But at the end of the day, every business can contain risks that exist outside of the balance sheet. Be aware that Clean Seas Seafood displays 2 warning signs in our investment analysis and 1 of them is a little worrying…
If, after all that, you’re more interested in a fast-growing company with a strong balance sheet, check out our list of cash-flowing growth stocks without further ado.
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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.
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