Is Babylon Pump & Power (ASX:BPP) Weighed On By Its Debt Load?

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. As with many other companies Babylon Pump & Power Limited (ASX:BPP) makes use of debt. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free 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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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 step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Babylon Pump & Power

What Is Babylon Pump & Power's Net Debt?

As you can see below, at the end of June 2021, Babylon Pump & Power had AU$13.8m of debt, up from AU$9.31m a year ago. Click the image for more detail. However, it also had AU$1.03m in cash, and so its net debt is AU$12.8m.

A Look At Babylon Pump & Power's Liabilities

The latest balance sheet data shows that Babylon Pump & Power had liabilities of AU$14.8m due within a year, and liabilities of AU$6.29m falling due after that. On the other hand, it had cash of AU$1.03m and AU$4.00m worth of receivables due within a year. So its liabilities total AU$16.0m more than the combination of its cash and short-term receivables.

This deficit is considerable relative to its market capitalization of AU$16.1m, so it does suggest shareholders should keep an eye on Babylon Pump & Power's use of debt. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Babylon Pump & Power will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

In the last year Babylon Pump & Power wasn't profitable at an EBIT level, but managed to grow its revenue by 24%, to AU$21m. With any luck the company will be able to grow its way to profitability.

Caveat Emptor

Even though Babylon Pump & Power managed to grow its top line quite deftly, the cold hard truth is that it is losing money on the EBIT line. Its EBIT loss was a whopping AU$4.0m. 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. Another cause for caution is that is bled AU$7.9m in negative free cash flow over the last twelve months. So in short it's a really risky stock. 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. We've identified 5 warning signs with Babylon Pump & Power (at least 2 which are a bit concerning) , and understanding them should be part of your investment process.

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.
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