Legendary fund manager Li Lu (who Charlie Munger backed) once said, ‘The biggest investment risk is not the volatility of prices, but whether you will suffer a 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. As with many other companies TransAct Technologies Incorporated (N;ASDAQ:TACT) makes use of debt. But the more important question is: how much risk is that debt creating?
What Risk Does Debt Bring?
Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. 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. When we think about a company’s use of debt, we first look at cash and debt together.
What Is TransAct Technologies’s Debt?
The image below, which you can click on for greater detail, shows that at March 2021 TransAct Technologies had debt of US$2.17m, up from US$794.0k in one year. However, its balance sheet shows it holds US$8.73m in cash, so it actually has US$6.56m net cash.
A Look At TransAct Technologies’ Liabilities
According to the last reported balance sheet, TransAct Technologies had liabilities of US$5.80m due within 12 months, and liabilities of US$5.20m due beyond 12 months. Offsetting these obligations, it had cash of US$8.73m as well as receivables valued at US$4.71m due within 12 months. So it actually has US$2.44m more liquid assets than total liabilities.
This short term liquidity is a sign that TransAct Technologies could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, TransAct Technologies boasts net cash, so it’s fair to say it does not have a heavy debt load! When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if TransAct Technologies can strengthen its balance sheet over time.
In the last year TransAct Technologies had a loss before interest and tax, and actually shrunk its revenue by 36%, to US$29m. To be frank that doesn’t bode well.
So How Risky Is TransAct Technologies?
Statistically speaking companies that lose money are riskier than those that make money. And in the last year TransAct Technologies had an earnings before interest and tax (EBIT) loss, truth be told. Indeed, in that time it burnt through US$3.5m of cash and made a loss of US$6.8m. Given it only has net cash of US$6.56m, the company may need to raise more capital if it doesn’t reach break-even soon. Overall, its balance sheet doesn’t seem overly risky, at the moment, but we’re always cautious until we see the positive free cash flow. 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.