We Think Lark Distilling (ASX:LRK) Is Taking Some Risk With Its Debt

·4 min read

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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. As with many other companies Lark Distilling Co. Ltd (ASX:LRK) makes use of debt. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Lark Distilling

How Much Debt Does Lark Distilling Carry?

The chart below, which you can click on for greater detail, shows that Lark Distilling had AU$5.00m in debt in June 2021; about the same as the year before. But on the other hand it also has AU$7.65m in cash, leading to a AU$2.65m net cash position.

debt-equity-history-analysis
debt-equity-history-analysis

How Healthy Is Lark Distilling's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Lark Distilling had liabilities of AU$3.40m due within 12 months and liabilities of AU$6.57m due beyond that. Offsetting this, it had AU$7.65m in cash and AU$2.34m in receivables that were due within 12 months. So its total liabilities are just about perfectly matched by its shorter-term, liquid assets.

Having regard to Lark Distilling's size, it seems that its liquid assets are well balanced with its total liabilities. So it's very unlikely that the AU$319.3m company is short on cash, but still worth keeping an eye on the balance sheet. Simply put, the fact that Lark Distilling has more cash than debt is arguably a good indication that it can manage its debt safely.

Notably, Lark Distilling made a loss at the EBIT level, last year, but improved that to positive EBIT of AU$864k in the last twelve months. 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 Lark Distilling'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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Lark Distilling has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. During the last year, Lark Distilling burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Summing up

While it is always sensible to investigate a company's debt, in this case Lark Distilling has AU$2.65m in net cash and a decent-looking balance sheet. So while Lark Distilling does not have a great balance sheet, it's certainly not too bad. 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. We've identified 1 warning sign with Lark Distilling , and understanding them should be part of your investment process.

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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