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. 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, Orbital Corporation Limited (ASX:OEC) does carry debt. But the real question is whether this debt is making the company risky.
Why Does Debt Bring Risk?
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. If things get really bad, the lenders can take control of the business. 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. 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 examine debt levels, we first consider both cash and debt levels, together.
What Is Orbital's Net Debt?
The image below, which you can click on for greater detail, shows that at June 2019 Orbital had debt of AU$8.28m, up from AU$7.77m in one year. However, because it has a cash reserve of AU$7.49m, its net debt is less, at about AU$790.0k.
How Strong Is Orbital's Balance Sheet?
We can see from the most recent balance sheet that Orbital had liabilities of AU$9.40m falling due within a year, and liabilities of AU$8.46m due beyond that. Offsetting this, it had AU$7.49m in cash and AU$7.06m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by AU$3.31m.
Of course, Orbital has a market capitalization of AU$23.2m, so these liabilities are probably manageable. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Orbital's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.
In the last year Orbital had negative earnings before interest and tax, and actually shrunk its revenue by 27%, to AU$15m. To be frank that doesn't bode well.
While Orbital's falling revenue is about as heartwarming as a wet blanket, arguably its earnings before interest and tax (EBIT) loss is even less appealing. Its EBIT loss was a whopping AU$6.0m. Considering that alongside the liabilities mentioned above does not give us much confidence that company should be using so much debt. So we think its balance sheet is a little strained, though not beyond repair. However, it doesn't help that it burned through AU$3.6m of cash over the last year. So in short it's a really risky stock. When I consider a company to be a bit risky, I think it is responsible to check out whether insiders have been reporting any share sales. Luckily, you can click here ito see our graphic depicting Orbital insider transactions.
Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.
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