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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.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. As with many other companies The GO2 People Limited (ASX:GO2) makes use of debt. But should shareholders be worried about its use of debt?
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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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 GO2 People's Net Debt?
The chart below, which you can click on for greater detail, shows that GO2 People had AU$3.08m in debt in June 2021; about the same as the year before. But it also has AU$6.38m in cash to offset that, meaning it has AU$3.29m net cash.
A Look At GO2 People's Liabilities
Zooming in on the latest balance sheet data, we can see that GO2 People had liabilities of AU$17.9m due within 12 months and liabilities of AU$7.74m due beyond that. Offsetting this, it had AU$6.38m in cash and AU$8.41m in receivables that were due within 12 months. So it has liabilities totalling AU$10.8m more than its cash and near-term receivables, combined.
This is a mountain of leverage relative to its market capitalization of AU$12.2m. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution. Despite its noteworthy liabilities, GO2 People boasts net cash, so it's fair to say it does not have a heavy debt load! The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since GO2 People will need earnings to service that debt. 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 GO2 People wasn't profitable at an EBIT level, but managed to grow its revenue by 2.1%, to AU$30m. That rate of growth is a bit slow for our taste, but it takes all types to make a world.
So How Risky Is GO2 People?
By their very nature companies that are losing money are more risky than those with a long history of profitability. And in the last year GO2 People had an earnings before interest and tax (EBIT) loss, truth be told. Indeed, in that time it burnt through AU$324k of cash and made a loss of AU$2.2m. With only AU$3.29m on the balance sheet, it would appear that its going to need to raise capital again soon. Summing up, we're a little skeptical of this one, as it seems fairly risky in the absence of free cashflow. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 4 warning signs for GO2 People you should be aware of, and 3 of them don't sit too well with us.
If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.
This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
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