The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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 Establishment Labs Holdings Inc. (NASDAQ:ESTA) makes use of debt. But is this debt a concern to shareholders?

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free 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 frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

How Much Debt Does Establishment Labs Holdings Carry?

You can click the graphic below for the historical numbers, but it shows that as of March 2024 Establishment Labs Holdings had US$192.2m of debt, an increase on US$178.6m, over one year. However, because it has a cash reserve of US$73.0m, its net debt is less, at about US$119.2m.

How Strong Is Establishment Labs Holdings' Balance Sheet?

The latest balance sheet data shows that Establishment Labs Holdings had liabilities of US$48.0m due within a year, and liabilities of US$196.9m falling due after that. Offsetting this, it had US$73.0m in cash and US$50.8m in receivables that were due within 12 months. So its liabilities total US$121.1m more than the combination of its cash and short-term receivables.

Of course, Establishment Labs Holdings has a market capitalization of US$1.20b, so these liabilities are probably manageable. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. 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 Establishment Labs Holdings 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.

In the last year Establishment Labs Holdings had a loss before interest and tax, and actually shrunk its revenue by 8.2%, to US$156m. We would much prefer see growth.

Caveat Emptor

Importantly, Establishment Labs Holdings had an earnings before interest and tax (EBIT) loss over the last year. To be specific the EBIT loss came in at US$66m. Considering that alongside the liabilities mentioned above does not give us much confidence that company should be using so much debt. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. Another cause for caution is that is bled US$106m in negative free cash flow over the last twelve months. So in short it's a really risky stock. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. For example - Establishment Labs Holdings has 2 warning signs we think you should be aware of.

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.

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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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com