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. We can see that Sportscene Group Inc. (CVE:SPS.A) does use debt in its business. But is this debt a concern to shareholders?
Why Does Debt Bring Risk?
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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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. The first step when considering a company’s debt levels is to consider its cash and debt together.
What Is Sportscene Group’s Net Debt?
You can click the graphic below for the historical numbers, but it shows that as of November 2020 Sportscene Group had CA$28.5m of debt, an increase on CA$15.1m, over one year. However, it does have CA$8.28m in cash offsetting this, leading to net debt of about CA$20.2m.
A Look At Sportscene Group’s Liabilities
Zooming in on the latest balance sheet data, we can see that Sportscene Group had liabilities of CA$18.4m due within 12 months and liabilities of CA$54.1m due beyond that. Offsetting these obligations, it had cash of CA$8.28m as well as receivables valued at CA$10.3m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CA$54.0m.
Given this deficit is actually higher than the company’s market capitalization of CA$50.0m, we think shareholders really should watch Sportscene Group’s debt levels, like a parent watching their child ride a bike for the first time. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer extensive dilution. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Sportscene Group’s earnings that will influence how the balance sheet holds up in the future. So if you’re keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.
In the last year Sportscene Group had a loss before interest and tax, and actually shrunk its revenue by 36%, to CA$85m. That makes us nervous, to say the least.
Caveat Emptor
Not only did Sportscene Group’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 CA$4.8m. When we look at that alongside the significant liabilities, we’re not particularly confident about the company. We’d want to see some strong near-term improvements before getting too interested in the stock. Not least because it had negative free cash flow of CA$4.7m over the last twelve months. So suffice it to say we consider the stock to be risky. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet.