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 seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. Importantly, Madalena Energy Inc. (CVE:MVN) does carry debt. But is this debt a concern to shareholders?
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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.
How Much Debt Does Madalena Energy Carry?
The image below, which you can click on for greater detail, shows that at June 2019 Madalena Energy had debt of US$5.52m, up from US$2.62m in one year. However, it also had US$1.76m in cash, and so its net debt is US$3.76m.
A Look At Madalena Energy's Liabilities
We can see from the most recent balance sheet that Madalena Energy had liabilities of US$11.8m falling due within a year, and liabilities of US$19.8m due beyond that. On the other hand, it had cash of US$1.76m and US$4.49m worth of receivables due within a year. So its liabilities total US$25.3m more than the combination of its cash and short-term receivables.
This is a mountain of leverage relative to its market capitalization of US$35.4m. This suggests shareholders would heavily diluted if the company needed to shore up its balance sheet in a hurry. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Madalena Energy will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.
Over 12 months, Madalena Energy made a loss at the EBIT level, and saw its revenue drop to US$28m, which is a fall of 12%. That's not what we would hope to see.
Not only did Madalena Energy's revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). Indeed, it lost a very considerable US$4.7m at the EBIT level. 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. However, it doesn't help that it burned through US$3.8m of cash over the last year. So suffice it to say we consider the stock very risky. When I consider a company to be a bit risky, I think it is responsible to check out whether insiders have been reporting any share sales. Luckily, you can click here ito see our graphic depicting Madalena Energy insider transactions.
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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