Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about. 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. Importantly, Eneco Refresh Limited (ASX:ERG) does carry debt. But the more important question is: how much risk is that debt creating?
Why Does Debt Bring Risk?
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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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 thing to do when considering how much debt a business uses is to look at its cash and debt together.
What Is Eneco Refresh's Debt?
You can click the graphic below for the historical numbers, but it shows that Eneco Refresh had AU$600.0k of debt in June 2019, down from AU$942.2k, one year before. But it also has AU$2.26m in cash to offset that, meaning it has AU$1.66m net cash.
How Strong Is Eneco Refresh's Balance Sheet?
The latest balance sheet data shows that Eneco Refresh had liabilities of AU$1.75m due within a year, and liabilities of AU$467.7k falling due after that. Offsetting these obligations, it had cash of AU$2.26m as well as receivables valued at AU$1.02m due within 12 months. So it actually has AU$1.07m more liquid assets than total liabilities.
This short term liquidity is a sign that Eneco Refresh could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that Eneco Refresh has more cash than debt is arguably a good indication that it can manage its debt safely. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Eneco Refresh's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.
In the last year Eneco Refresh wasn't profitable at an EBIT level, but managed to grow its revenue by3.4%, to AU$9.1m. That rate of growth is a bit slow for our taste, but it takes all types to make a world.
So How Risky Is Eneco Refresh?
We have no doubt that loss making companies are, in general, riskier than profitable ones. And in the last year Eneco Refresh had negative earnings before interest and tax (EBIT), truth be told. Indeed, in that time it burnt through AU$5.3m of cash and made a loss of AU$997k. With only AU$1.66m on the balance sheet, it would appear that its going to need to raise capital again soon. Even though its balance sheet seems sufficiently liquid, debt always makes us a little nervous if a company doesn't produce free cash flow regularly. For riskier companies like Eneco Refresh 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.
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.
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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. Thank you for reading.