We Think Brookside Energy (ASX:BRK) Can Stay On Top Of Its Debt

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. As with many other companies Brookside Energy Limited (ASX:BRK) makes use of debt. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Brookside Energy

How Much Debt Does Brookside Energy Carry?

The image below, which you can click on for greater detail, shows that at June 2022 Brookside Energy had debt of AU$8.16m, up from AU$4.09m in one year. But it also has AU$34.5m in cash to offset that, meaning it has AU$26.4m net cash.

A Look At Brookside Energy's Liabilities

Zooming in on the latest balance sheet data, we can see that Brookside Energy had liabilities of AU$21.4m due within 12 months and liabilities of AU$72.6k due beyond that. Offsetting these obligations, it had cash of AU$34.5m as well as receivables valued at AU$5.50m due within 12 months. So it actually has AU$18.6m more liquid assets than total liabilities.

This surplus liquidity suggests that Brookside Energy's balance sheet could take a hit just as well as Homer Simpson's head can take a punch. With this in mind one could posit that its balance sheet means the company is able to handle some adversity. Succinctly put, Brookside Energy boasts net cash, so it's fair to say it does not have a heavy debt load!

Notably, Brookside Energy made a loss at the EBIT level, last year, but improved that to positive EBIT of AU$4.8m in the last twelve months. 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 Brookside Energy 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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While Brookside Energy has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Over the last year, Brookside Energy saw substantial negative free cash flow, in total. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Summing Up

While it is always sensible to investigate a company's debt, in this case Brookside Energy has AU$26.4m in net cash and a decent-looking balance sheet. So we don't have any problem with Brookside Energy's use of debt. 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. For example, we've discovered 4 warning signs for Brookside Energy (2 are significant!) that you should be aware of before investing here.

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. 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.