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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 might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We can see that Mexco Energy Corporation (NYSEMKT:MXC) does use debt in its business. But should shareholders be worried about its use of debt?
Why Does Debt Bring Risk?
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. If things get really bad, the lenders can take control of the business. 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.
How Much Debt Does Mexco Energy Carry?
As you can see below, Mexco Energy had US$189.1k of debt at June 2019, down from US$500.0k a year prior. However, because it has a cash reserve of US$150.4k, its net debt is less, at about US$38.7k.
A Look At Mexco Energy's Liabilities
Zooming in on the latest balance sheet data, we can see that Mexco Energy had liabilities of US$217.9k due within 12 months and liabilities of US$1.11m due beyond that. On the other hand, it had cash of US$150.4k and US$371.5k worth of receivables due within a year. So it has liabilities totalling US$807.7k more than its cash and near-term receivables, combined.
Given Mexco Energy has a market capitalization of US$9.18m, it's hard to believe these liabilities pose much threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. But either way, Mexco Energy has virtually no net debt, so it's fair to say it does not have a heavy debt load! When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Mexco Energy will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.
Over 12 months, Mexco Energy saw its revenue drop to US$2.6m, which is a fall of 5.4%. That's not what we would hope to see.
Over the last twelve months Mexco Energy produced an earnings before interest and tax (EBIT) loss. To be specific the EBIT loss came in at US$61k. 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. Another cause for caution is that is bled US$60k in negative free cash flow over the last twelve months. So to be blunt we think it is 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 Mexco Energy insider transactions.
When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.
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