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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. When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We note that Hydrix Limited (ASX:HYD) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.
When Is Debt Dangerous?
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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.
See our latest analysis for Hydrix
What Is Hydrix's Net Debt?
The image below, which you can click on for greater detail, shows that at June 2019 Hydrix had debt of AU$4.23m, up from AU$3.25m in one year. On the flip side, it has AU$234.6k in cash leading to net debt of about AU$4.00m.
How Strong Is Hydrix's Balance Sheet?
We can see from the most recent balance sheet that Hydrix had liabilities of AU$10.1m falling due within a year, and liabilities of AU$1.60m due beyond that. Offsetting these obligations, it had cash of AU$234.6k as well as receivables valued at AU$6.65m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by AU$4.79m.
This deficit isn't so bad because Hydrix is worth AU$20.7m, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution. When analysing debt levels, the balance sheet is the obvious place to start. But it is Hydrix's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.
Over 12 months, Hydrix reported revenue of AU$14m, which is a gain of 148%, although it did not report any earnings before interest and tax. So its pretty obvious shareholders are hoping for more growth!