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'. It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. As with many other companies Enero Group Limited (ASX:EGG) makes use of debt. 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. If things get really bad, the lenders can take control of the business. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.
How Much Debt Does Enero Group Carry?
You can click the graphic below for the historical numbers, but it shows that as of December 2019 Enero Group had AU$19.3m of debt, an increase on none, over one year. However, its balance sheet shows it holds AU$37.0m in cash, so it actually has AU$17.7m net cash.
A Look At Enero Group's Liabilities
According to the last reported balance sheet, Enero Group had liabilities of AU$66.4m due within 12 months, and liabilities of AU$24.1m due beyond 12 months. Offsetting this, it had AU$37.0m in cash and AU$37.5m in receivables that were due within 12 months. So its liabilities total AU$16.1m more than the combination of its cash and short-term receivables.
Of course, Enero Group has a market capitalization of AU$162.7m, 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. Despite its noteworthy liabilities, Enero Group boasts net cash, so it's fair to say it does not have a heavy debt load!
Also positive, Enero Group grew its EBIT by 24% in the last year, and that should make it easier to pay down debt, going forward. 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 Enero Group's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Enero Group may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Happily for any shareholders, Enero Group actually produced more free cash flow than EBIT over the last three years. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.
While it is always sensible to look at a company's total liabilities, it is very reassuring that Enero Group has AU$17.7m in net cash. And it impressed us with free cash flow of AU$21m, being 102% of its EBIT. So is Enero Group's debt a risk? It doesn't seem so to us. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 3 warning signs for Enero Group you should be aware of.
At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.
If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. 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.
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