Warren Buffett famously said, ‘Volatility is far from synonymous with risk.’ So it seems the smart money knows that debt – which is usually involved in bankruptcies – is a very important factor, when you assess how risky a company is. Importantly, Petsec Energy Ltd (ASX:PSA) does carry debt. But is this debt a concern to shareholders?
When Is Debt Dangerous?
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 frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
What Is Petsec Energy’s Debt?
The image below, which you can click on for greater detail, shows that at December 2018 Petsec Energy had debt of US$9.48m, up from US$5.57m in one year. On the flip side, it has US$2.60m in cash leading to net debt of about US$6.89m.
How Healthy Is Petsec Energy’s Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Petsec Energy had liabilities of US$3.11m due within 12 months and liabilities of US$19.5m due beyond that. Offsetting this, it had US$2.60m in cash and US$810.0k in receivables that were due within 12 months. So it has liabilities totalling US$19.2m more than its cash and near-term receivables, combined.
When you consider that this deficiency exceeds the company’s US$15.7m market capitalization, you might well be inclined to review the balance sheet, just like one might study a new partner’s social media. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price. When analysing debt levels, the balance sheet is the obvious place to start. But it is Petsec Energy’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.
Over 12 months, Petsec Energy reported revenue of US$3.1m, which is a gain of 139%. So there’s no doubt that shareholders are cheering for growth
While we can certainly savour Petsec Energy’s tasty revenue growth, its negative earnings before interest and tax (EBIT) leaves a bitter aftertaste. Its EBIT loss was a whopping US$5.2m. Considering that alongside the liabilities mentioned above make us nervous about the company. We’d want to see some strong near-term improvements before getting too interested in the stock. Not least because it had negative free cash flow of US$6.4m over the last twelve months. That means it’s on the risky side of things. For riskier companies like Petsec Energy I always like to keep an eye on the long term profit and revenue trends. Fortunately, you can click to see our interactive graph of its profit, revenue, and operating cashflow.
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 email@example.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.