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, HEXO Corp. (TSE:HEXO) does carry debt. But the real question is whether this debt is making the company risky.
When Is Debt Dangerous?
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. Ultimately, if the company can’t fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company’s use of debt, we first look at cash and debt together.
What Is HEXO’s Net Debt?
You can click the graphic below for the historical numbers, but it shows that HEXO had CA$59.2m of debt in January 2021, down from CA$79.0m, one year before. But it also has CA$129.4m in cash to offset that, meaning it has CA$70.1m net cash.
How Healthy Is HEXO’s Balance Sheet?
Zooming in on the latest balance sheet data, we can see that HEXO had liabilities of CA$73.7m due within 12 months and liabilities of CA$81.4m due beyond that. On the other hand, it had cash of CA$129.4m and CA$45.2m worth of receivables due within a year. So it actually has CA$19.4m more liquid assets than total liabilities.
This surplus suggests that HEXO has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that HEXO has more cash than debt is arguably a good indication that it can manage its debt safely. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if HEXO can strengthen its balance sheet over time. 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, HEXO reported revenue of CA$112m, which is a gain of 86%, although it did not report any earnings before interest and tax. Shareholders probably have their fingers crossed that it can grow its way to profits.
So How Risky Is HEXO?
Statistically speaking companies that lose money are riskier than those that make money. And the fact is that over the last twelve months HEXO lost money at the earnings before interest and tax (EBIT) line. And over the same period it saw negative free cash outflow of CA$66m and booked a CA$213m accounting loss. With only CA$70.1m on the balance sheet, it would appear that its going to need to raise capital again soon. With very solid revenue growth in the last year, HEXO may be on a path to profitability. Pre-profit companies are often risky, but they can also offer great rewards. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet.
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