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. Importantly, Cronos Australia Limited ( ASX:CAU ) does carry debt. But the real question is whether this debt is making the company risky.
When Is Debt Dangerous?
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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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, 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 examine debt levels, we first consider both cash and debt levels, together.
How Much Debt Does Cronos Australia Carry?
As you can see below, at the end of June 2022, Cronos Australia had AU$5.06m of debt, up from AU$2.01m a year ago. This debt largely relates to Cronos taking on several long-term lease liabillities for office and warehousing space. While this may look unsual at first glance, the accounting standards consider lease liabilities longer than 12 months to be similar to taking out a loan. Click the image for more detail. However, it does have AU$16.1m in cash offsetting this, leading to net cash of AU$11.0m.
How Strong Is Cronos Australia's Balance Sheet?
According to the last reported balance sheet, Cronos Australia had liabilities of AU$12.2m due within 12 months, and liabilities of AU$4.62m due beyond 12 months. On the other hand, it had cash of AU$16.1m and AU$5.76m worth of receivables due within a year. So it actually has AU$5.04m more liquid assets than total liabilities.
This surplus suggests that Cronos Australia has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, Cronos Australia boasts net cash, so it's fair to say it does not have a heavy debt load!
Although Cronos Australia made a loss at the EBIT level, last year, it was also good to see that it generated AU$9.9m in EBIT over the last twelve months. When analysing debt levels, the balance sheet is the obvious place to start. But it is Cronos Australia's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot .
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Cronos Australia may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Over the last year, Cronos Australia actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.
While we empathize with investors who find debt concerning, you should keep in mind that Cronos Australia has net cash of AU$11.0m, as well as more liquid assets than liabilities. And it impressed us with free cash flow of AU$13m, being 132% of its EBIT. So we don't think Cronos Australia's use of debt is risky. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for Cronos Australia (of which 1 makes us a bit uncomfortable!) you should know about.
Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks , today.
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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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