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.’ 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. As with many other companies Capstone Turbine Corporation (NASDAQ:CPST) makes use of debt. But is this debt a concern to shareholders?
What Risk Does Debt Bring?
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. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
How Much Debt Does Capstone Turbine Carry?
You can click the graphic below for the historical numbers, but it shows that as of December 2020 Capstone Turbine had US$53.0m of debt, an increase on US$27.8m, over one year. However, it does have US$32.0m in cash offsetting this, leading to net debt of about US$21.0m.
How Healthy Is Capstone Turbine’s Balance Sheet?
We can see from the most recent balance sheet that Capstone Turbine had liabilities of US$23.2m falling due within a year, and liabilities of US$58.3m due beyond that. On the other hand, it had cash of US$32.0m and US$19.1m worth of receivables due within a year. So it has liabilities totalling US$30.5m more than its cash and near-term receivables, combined.
While this might seem like a lot, it is not so bad since Capstone Turbine has a market capitalization of US$81.2m, and so it could probably strengthen its balance sheet by raising capital if it needed to. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. 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 Capstone Turbine’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.
Over 12 months, Capstone Turbine made a loss at the EBIT level, and saw its revenue drop to US$61m, which is a fall of 23%. That makes us nervous, to say the least.
Not only did Capstone Turbine’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 US$11m. 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. So we think its balance sheet is a little strained, though not beyond repair. Another cause for caution is that is bled US$8.9m in negative free cash flow over the last twelve months. So in short it’s a really risky stock. 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.