David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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 MGC Pharmaceuticals Limited (ASX:MXC) makes use of debt. But the more important question is: how much risk is that debt creating?
Why Does Debt Bring Risk?
Debt assists a business until the business has trouble paying it off, either with new capital or with free 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
What Is MGC Pharmaceuticals's Debt?
The image below, which you can click on for greater detail, shows that at December 2021 MGC Pharmaceuticals had debt of AU$2.32m, up from AU$72.5k in one year. But it also has AU$8.06m in cash to offset that, meaning it has AU$5.75m net cash.
How Healthy Is MGC Pharmaceuticals' Balance Sheet?
Zooming in on the latest balance sheet data, we can see that MGC Pharmaceuticals had liabilities of AU$6.69m due within 12 months and liabilities of AU$4.98m due beyond that. Offsetting these obligations, it had cash of AU$8.06m as well as receivables valued at AU$1.94m due within 12 months. So its liabilities total AU$1.66m more than the combination of its cash and short-term receivables.
Of course, MGC Pharmaceuticals has a market capitalization of AU$68.0m, 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. Despite its noteworthy liabilities, MGC Pharmaceuticals 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 ultimately the future profitability of the business will decide if MGC Pharmaceuticals 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.
In the last year MGC Pharmaceuticals wasn't profitable at an EBIT level, but managed to grow its revenue by 359%, to AU$4.8m. That's virtually the hole-in-one of revenue growth!
So How Risky Is MGC Pharmaceuticals?
By their very nature companies that are losing money are more risky than those with a long history of profitability. And the fact is that over the last twelve months MGC Pharmaceuticals lost money at the earnings before interest and tax (EBIT) line. And over the same period it saw negative free cash outflow of AU$16m and booked a AU$17m accounting loss. Given it only has net cash of AU$5.75m, the company may need to raise more capital if it doesn't reach break-even soon. Importantly, MGC Pharmaceuticals's revenue growth is hot to trot. While unprofitable companies can be risky, they can also grow hard and fast in those pre-profit years. 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. We've identified 6 warning signs with MGC Pharmaceuticals (at least 1 which shouldn't be ignored) , and understanding them should be part of your investment process.
When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.
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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.