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Here's Why Cue Energy Resources (ASX:CUE) Can Manage Its Debt Responsibly

·4 min read

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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. We can see that Cue Energy Resources Limited (ASX:CUE) does use debt in its business. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Cue Energy Resources

What Is Cue Energy Resources's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of June 2022 Cue Energy Resources had AU$6.90m of debt, an increase on none, over one year. But it also has AU$23.2m in cash to offset that, meaning it has AU$16.3m net cash.

debt-equity-history-analysis
debt-equity-history-analysis

How Strong Is Cue Energy Resources' Balance Sheet?

We can see from the most recent balance sheet that Cue Energy Resources had liabilities of AU$15.5m falling due within a year, and liabilities of AU$43.5m due beyond that. On the other hand, it had cash of AU$23.2m and AU$8.57m worth of receivables due within a year. So its liabilities total AU$27.2m more than the combination of its cash and short-term receivables.

While this might seem like a lot, it is not so bad since Cue Energy Resources has a market capitalization of AU$49.6m, and so it could probably strengthen its balance sheet by raising capital if it needed to. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. While it does have liabilities worth noting, Cue Energy Resources also has more cash than debt, so we're pretty confident it can manage its debt safely.

It was also good to see that despite losing money on the EBIT line last year, Cue Energy Resources turned things around in the last 12 months, delivering and EBIT of AU$21m. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Cue Energy Resources 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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Cue Energy Resources 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. During the last year, Cue Energy Resources produced sturdy free cash flow equating to 53% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing Up

Although Cue Energy Resources's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of AU$16.3m. So we don't have any problem with Cue Energy Resources's use of debt. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should learn about the 2 warning signs we've spotted with Cue Energy Resources (including 1 which makes us a bit uncomfortable) .

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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

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.

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