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

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.' 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. As with many other companies Babylon Pump & Power Limited (ASX:BPP) makes use of debt. But should shareholders be worried about its use of debt?

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. If things get really bad, the lenders can take control of the business. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Babylon Pump & Power

What Is Babylon Pump & Power's Debt?

As you can see below, Babylon Pump & Power had AU$11.7m of debt at December 2022, down from AU$17.3m a year prior. However, it does have AU$2.13m in cash offsetting this, leading to net debt of about AU$9.56m.

How Strong 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$18.1m due within 12 months and liabilities of AU$6.66m due beyond that. On the other hand, it had cash of AU$2.13m and AU$5.22m worth of receivables due within a year. So it has liabilities totalling AU$17.4m more than its cash and near-term receivables, combined.

Given this deficit is actually higher than the company's market capitalization of AU$14.7m, we think shareholders really should watch Babylon Pump & Power's debt levels, like a parent watching their child ride a bike for the first time. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer extensive dilution. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Babylon Pump & Power will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

In the last year Babylon Pump & Power wasn't profitable at an EBIT level, but managed to grow its revenue by 10%, to AU$28m. 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 Babylon Pump & Power produced an earnings before interest and tax (EBIT) loss. Its EBIT loss was a whopping AU$2.9m. 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 AU$206k over the last twelve months. That means it's on the risky side of things. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. For instance, we've identified 3 warning signs for Babylon Pump & Power that you should be aware of.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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.