Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk'. 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. Importantly, Aleafia Health Inc. (TSE:ALEF) does carry debt. But should shareholders be worried about its use of debt?
When Is Debt A Problem?
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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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 thing to do when considering how much debt a business uses is to look at its cash and debt together.
What Is Aleafia Health's Debt?
As you can see below, at the end of September 2019, Aleafia Health had CA$50.2m of debt, up from none a year ago. Click the image for more detail. But on the other hand it also has CA$57.2m in cash, leading to a CA$6.93m net cash position.
How Healthy Is Aleafia Health's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Aleafia Health had liabilities of CA$10.9m due within 12 months and liabilities of CA$53.4m due beyond that. Offsetting these obligations, it had cash of CA$57.2m as well as receivables valued at CA$8.47m due within 12 months. So it actually has CA$1.34m more liquid assets than total liabilities.
Having regard to Aleafia Health's size, it seems that its liquid assets are well balanced with its total liabilities. So it's very unlikely that the CA$169.5m company is short on cash, but still worth keeping an eye on the balance sheet. Simply put, the fact that Aleafia Health 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 Aleafia Health's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.
In the last year Aleafia Health wasn't profitable at an EBIT level, but managed to grow its revenue by 306%, to CA$11m. When it comes to revenue growth, that's like nailing the game winning 3-pointer!
So How Risky Is Aleafia Health?
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 Aleafia Health lost money at the earnings before interest and tax (EBIT) line. Indeed, in that time it burnt through CA$49m of cash and made a loss of CA$42m. But at least it has CA$6.93m on the balance sheet to spend on growth, near-term. Importantly, Aleafia Health's revenue growth is hot to trot. While unprofitable companies can be risky, they can also grow hard and fast in those pre-profit years. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. For example, we've discovered 3 warning signs for Aleafia Health (1 is a bit concerning!) that you should be aware of before investing here.
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.
If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. 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. Simply Wall St has no position in the stocks mentioned.
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