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. As with many other companies AMMO, Inc. (NASDAQ:POWW) makes use of debt. But the more important question is: how much risk is that debt creating?
When Is Debt Dangerous?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. 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, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.
What Is AMMO’s Net Debt?
The image below, which you can click on for greater detail, shows that AMMO had debt of US$8.47m at the end of March 2021, a reduction from US$10.8m over a year. However, it does have US$118.3m in cash offsetting this, leading to net cash of US$109.9m.
A Look At AMMO’s Liabilities
The latest balance sheet data shows that AMMO had liabilities of US$12.1m due within a year, and liabilities of US$6.93m falling due after that. Offsetting these obligations, it had cash of US$118.3m as well as receivables valued at US$9.01m due within 12 months. So it actually has US$108.3m more liquid assets than total liabilities.
This short term liquidity is a sign that AMMO could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that AMMO 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 ultimately the future profitability of the business will decide if AMMO can strengthen its balance sheet over time.
In the last year AMMO wasn’t profitable at an EBIT level, but managed to grow its revenue by 312%, to US$58m. That’s virtually the hole-in-one of revenue growth!
So How Risky Is AMMO?
By their very nature companies that are losing money are more risky than those with a long history of profitability. And we do note that AMMO had an earnings before interest and tax (EBIT) loss, over the last year. And over the same period it saw negative free cash outflow of US$22m and booked a US$7.8m accounting loss. Given it only has net cash of US$109.9m, the company may need to raise more capital if it doesn’t reach break-even soon. The good news for shareholders is that AMMO has dazzling revenue growth, so there’s a very good chance it can boost its free cash flow in the years to come. High growth pre-profit companies may well be risky, but they can also offer great rewards. The balance sheet is clearly the area to focus on when you are analysing debt.