Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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. Importantly, IRIDEX Corporation (NASDAQ:IRIX) does carry debt. But is this debt a concern to shareholders?
When Is Debt Dangerous?
Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. 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 thing to do when considering how much debt a business uses is to look at its cash and debt together.
What Is IRIDEX's Debt?
As you can see below, at the end of June 2020, IRIDEX had US$2.50m of debt, up from none a year ago. Click the image for more detail. But it also has US$11.6m in cash to offset that, meaning it has US$9.13m net cash.
How Strong Is IRIDEX's Balance Sheet?
The latest balance sheet data shows that IRIDEX had liabilities of US$7.58m due within a year, and liabilities of US$2.91m falling due after that. Offsetting these obligations, it had cash of US$11.6m as well as receivables valued at US$5.78m due within 12 months. So it can boast US$6.93m more liquid assets than total liabilities.
It's good to see that IRIDEX has plenty of liquidity on its balance sheet, suggesting conservative management of liabilities. Because it has plenty of assets, it is unlikely to have trouble with its lenders. Succinctly put, IRIDEX boasts net cash, so it's fair to say it does not have a heavy debt load! There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine IRIDEX's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.
Over 12 months, IRIDEX made a loss at the EBIT level, and saw its revenue drop to US$38m, which is a fall of 14%. That's not what we would hope to see.
So How Risky Is IRIDEX?
We have no doubt that loss making companies are, in general, riskier than profitable ones. And the fact is that over the last twelve months IRIDEX lost money at the earnings before interest and tax (EBIT) line. And over the same period it saw negative free cash outflow of US$6.3m and booked a US$7.8m accounting loss. However, it has net cash of US$9.13m, so it has a bit of time before it will need more capital. Even though its balance sheet seems sufficiently liquid, debt always makes us a little nervous if a company doesn't produce free cash flow regularly. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. Consider risks, for instance. Every company has them, and we've spotted 2 warning signs for IRIDEX you should know about.
If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.
This article by Simply Wall St is general in nature. 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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