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Is STEP Energy Services (TSE:STEP) Using Debt Sensibly?

Simply Wall St

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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We note that STEP Energy Services Ltd. (TSE:STEP) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for STEP Energy Services

What Is STEP Energy Services's Debt?

As you can see below, STEP Energy Services had CA$255.6m of debt at June 2019, down from CA$293.7m a year prior. Net debt is about the same, since the it doesn't have much cash.

TSX:STEP Historical Debt, August 21st 2019

How Strong Is STEP Energy Services's Balance Sheet?

The latest balance sheet data shows that STEP Energy Services had liabilities of CA$114.3m due within a year, and liabilities of CA$313.4m falling due after that. Offsetting these obligations, it had cash of CA$1.11m as well as receivables valued at CA$167.0m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CA$259.5m.

The deficiency here weighs heavily on the CA$109.5m company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we definitely think shareholders need to watch this one closely. After all, STEP Energy Services would likely require a major re-capitalisation if it had to pay its creditors today. 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 STEP Energy Services'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.

Over 12 months, STEP Energy Services reported revenue of CA$773m, which is a gain of 10%. That rate of growth is a bit slow for our taste, but it takes all types to make a world.

Caveat Emptor

Over the last twelve months STEP Energy Services produced an earnings before interest and tax (EBIT) loss. Indeed, it lost a very considerable CA$11m at the EBIT level. When we look at that alongside the significant liabilities, we're not particularly confident about the company. We'd want to see some strong near-term improvements before getting too interested in the stock. For example, we would not want to see a repeat of last year's loss of-CA$55.9m. And until that time we think this is a risky stock. For riskier companies like STEP Energy Services 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.

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.

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.