Is Genel Energy (LON:GENL) Using Too Much Debt?

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. 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 can see that Genel Energy plc (LON:GENL) does use debt in its business. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. 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. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Genel Energy

What Is Genel Energy's Debt?

As you can see below, Genel Energy had US$297.9m of debt, at December 2019, which is about the same as the year before. You can click the chart for greater detail. But on the other hand it also has US$390.7m in cash, leading to a US$92.8m net cash position.

How Healthy Is Genel Energy's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Genel Energy had liabilities of US$96.7m due within 12 months and liabilities of US$480.8m due beyond that. Offsetting this, it had US$390.7m in cash and US$157.4m in receivables that were due within 12 months. So it has liabilities totalling US$29.4m more than its cash and near-term receivables, combined.

Of course, Genel Energy has a market capitalization of US$421.0m, so these liabilities are probably manageable. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. Despite its noteworthy liabilities, Genel Energy boasts net cash, so it's fair to say it does not have a heavy debt load!

Notably, Genel Energy made a loss at the EBIT level, last year, but improved that to positive EBIT of US$128m in the last twelve months. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Genel Energy'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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Genel Energy 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, Genel Energy generated free cash flow amounting to a very robust 96% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.

Summing up

We could understand if investors are concerned about Genel Energy's liabilities, but we can be reassured by the fact it has has net cash of US$92.8m. The cherry on top was that in converted 96% of that EBIT to free cash flow, bringing in US$123m. So we don't think Genel Energy's use of debt is risky. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. To that end, you should be aware of the 2 warning signs we've spotted with Genel Energy .

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.

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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. 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. Thank you for reading.