David Iben put it well when he said, ‘Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.’ So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We note that CRH Medical Corporation (TSE:CRH) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?
Why Does Debt Bring Risk?
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. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.
What Is CRH Medical’s Debt?
You can click the graphic below for the historical numbers, but it shows that as of September 2020 CRH Medical had US$75.2m of debt, an increase on US$68.2m, over one year. On the flip side, it has US$5.10m in cash leading to net debt of about US$70.1m.
How Strong Is CRH Medical’s Balance Sheet?
We can see from the most recent balance sheet that CRH Medical had liabilities of US$11.2m falling due within a year, and liabilities of US$78.6m due beyond that. On the other hand, it had cash of US$5.10m and US$23.6m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$61.1m.
CRH Medical has a market capitalization of US$203.1m, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But it’s clear that we should definitely closely examine whether it can manage its debt without dilution. There’s no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine CRH Medical’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 CRH Medical had a loss before interest and tax, and actually shrunk its revenue by 18%, to US$100m. We would much prefer see growth.
Not only did CRH Medical’s revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). To be specific the EBIT loss came in at US$7.9m. When we look at that and recall the liabilities on its balance sheet, relative to cash, it seems unwise to us for the company to have any debt. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. For example, we would not want to see a repeat of last year’s loss of US$4.1m. In the meantime, we consider the stock very risky. 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. Consider for instance, the ever-present spectre of investment risk. We’ve identified 3 warning signs with CRH Medical , and understanding them should be part of your investment process.
When all is said and done, sometimes its easier to focus on companies that don’t even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.
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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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