Is Babylon Pump & Power (ASX:BPP) A Risky Investment?

Legendary fund manager Li Lu (who Charlie Munger backed) once said, '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. As with many other companies Babylon Pump & Power Limited (ASX:BPP) makes use of debt. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, 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 Babylon Pump & Power

What Is Babylon Pump & Power's Debt?

You can click the graphic below for the historical numbers, but it shows that as of June 2020 Babylon Pump & Power had AU$9.31m of debt, an increase on AU$7.07m, over one year. However, it also had AU$3.56m in cash, and so its net debt is AU$5.75m.

How Healthy Is Babylon Pump & Power's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Babylon Pump & Power had liabilities of AU$12.6m due within 12 months and liabilities of AU$2.57m due beyond that. On the other hand, it had cash of AU$3.56m and AU$2.84m worth of receivables due within a year. So it has liabilities totalling AU$8.73m more than its cash and near-term receivables, combined.

This deficit isn't so bad because Babylon Pump & Power is worth AU$30.7m, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution. There's no doubt that we learn most about debt from the balance sheet. But it is Babylon Pump & Power'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, Babylon Pump & Power reported revenue of AU$17m, which is a gain of 49%, although it did not report any earnings before interest and tax. With any luck the company will be able to grow its way to profitability.

Caveat Emptor

Despite the top line growth, Babylon Pump & Power still had an earnings before interest and tax (EBIT) loss over the last year. To be specific the EBIT loss came in at AU$575k. 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 AU$1.4m in negative free cash flow over the last twelve months. So to be blunt we think it is risky. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 5 warning signs for Babylon Pump & Power you should be aware of, and 2 of them are a bit unpleasant.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.
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