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Is Empyrean Energy (LON:EME) Using Too Much Debt?

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 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. As with many other companies Empyrean Energy Plc (LON:EME) makes use of debt. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

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. 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Empyrean Energy

What Is Empyrean Energy's Net Debt?

You can click the graphic below for the historical numbers, but it shows that Empyrean Energy had US$1.32m of debt in September 2018, down from US$3.89m, one year before. However, it also had US$230.0k in cash, and so its net debt is US$1.09m.

AIM:EME Historical Debt, August 2nd 2019
AIM:EME Historical Debt, August 2nd 2019

How Healthy Is Empyrean Energy's Balance Sheet?

According to the balance sheet data, Empyrean Energy had liabilities of US$1.82m due within 12 months, but no longer term liabilities. Offsetting this, it had US$230.0k in cash and US$188.0k in receivables that were due within 12 months. So its liabilities total US$1.41m more than the combination of its cash and short-term receivables.

Of course, Empyrean Energy has a market capitalization of US$46.7m, so these liabilities are probably manageable. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Empyrean Energy's earnings that will influence how the balance sheet holds up in the future. 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.

Since Empyrean Energy doesn't have significant operating revenue, shareholders must hope it'll sell some fossil fuels, before it runs out of money.

Caveat Emptor

Over the last twelve months Empyrean Energy produced an earnings before interest and tax (EBIT) loss. To be specific the EBIT loss came in at US$766k. When we look at that and recall the liabilities on its balance sheet, relative to cash, it seems unwise to us for the company to have any 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$4.7m in negative free cash flow over the last twelve months. So suffice it to say we consider the stock very risky. For riskier companies like Empyrean Energy I always like to keep an eye on whether insiders are buying or selling. So click here if you want to find out for yourself.

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.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. 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. Simply Wall St has no position in the stocks mentioned. Thank you for reading.

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