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 can see that 22nd Century Group, Inc. (NASDAQ:XXII) does use debt in its business. But the real question is whether this debt is making the company risky.
What Risk Does Debt Bring?
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. Part and parcel of capitalism is the process of ‘creative destruction’ where failed businesses are mercilessly liquidated by their bankers. 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 22nd Century Group’s Net Debt?
The chart below, which you can click on for greater detail, shows that 22nd Century Group had US$1.78m in debt in September 2021; about the same as the year before. But it also has US$55.2m in cash to offset that, meaning it has US$53.4m net cash.
A Look At 22nd Century Group’s Liabilities
According to the last reported balance sheet, 22nd Century Group had liabilities of US$6.96m due within 12 months, and liabilities of US$479.0k due beyond 12 months. Offsetting this, it had US$55.2m in cash and US$1.18m in receivables that were due within 12 months. So it actually has US$48.9m more liquid assets than total liabilities.
This short term liquidity is a sign that 22nd Century Group could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, 22nd Century Group 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 ultimately the future profitability of the business will decide if 22nd Century Group can strengthen its balance sheet over time. So if you’re focused on the future you can check out this free report showing analyst profit forecasts.
Over 12 months, 22nd Century Group reported revenue of US$30m, which is a gain of 7.9%, although it did not report any earnings before interest and tax. We usually like to see faster growth from unprofitable companies, but each to their own.
So How Risky Is 22nd Century Group?
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 22nd Century Group lost money at the earnings before interest and tax (EBIT) line. And over the same period it saw negative free cash outflow of US$22m and booked a US$25m accounting loss. However, it has net cash of US$53.4m, 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. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet – far from it. We’ve identified 4 warning signs with 22nd Century Group (at least 1 which is a bit unpleasant) , 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.
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.
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.