Is Lekoil (LON:LEK) Using Debt In A Risky Way?

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. Importantly, Lekoil Limited (LON:LEK) does carry debt. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. Having said that, the most common situation is where a company manages its debt reasonably well – and to its own advantage. When we think about a company’s use of debt, we first look at cash and debt together.

Check out our latest analysis for Lekoil

How Much Debt Does Lekoil Carry?

As you can see below, Lekoil had US$15.7m of debt at June 2019, down from US$25.7m a year prior. However, it does have US$8.34m in cash offsetting this, leading to net debt of about US$7.41m.

AIM:LEK Historical Debt, February 24th 2020
AIM:LEK Historical Debt, February 24th 2020

How Strong Is Lekoil’s Balance Sheet?

According to the last reported balance sheet, Lekoil had liabilities of US$23.8m due within 12 months, and liabilities of US$7.49m due beyond 12 months. Offsetting these obligations, it had cash of US$8.34m as well as receivables valued at US$4.37m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$18.6m.

This deficit is considerable relative to its market capitalization of US$22.3m, so it does suggest shareholders should keep an eye on Lekoil’s use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution. 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 Lekoil’s ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Over 12 months, Lekoil reported revenue of US$49m, which is a gain of 5.0%, although it did not report any earnings before interest and tax. 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 Lekoil produced an earnings before interest and tax (EBIT) loss. Indeed, it lost US$308k at the EBIT level. When we look at that and recall the liabilities on its balance sheet, relative to cash, it seems unwise to us for the company to have any debt. So we think its balance sheet is a little strained, though not beyond repair. However, it doesn’t help that it burned through US$5.9m of cash over the last year. So suffice it to say we consider the stock very risky. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that Lekoil is showing 4 warning signs in our investment analysis , and 1 of those can’t be ignored…

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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