Stock Analysis

Does Cue Energy Resources (ASX:CUE) Have A Healthy Balance Sheet?

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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 Cue Energy Resources Limited (ASX:CUE) makes use of debt. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

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. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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.

See our latest analysis for Cue Energy Resources

What Is Cue Energy Resources's Net Debt?

As you can see below, at the end of December 2022, Cue Energy Resources had AU$6.92m of debt, up from none a year ago. Click the image for more detail. But it also has AU$11.3m in cash to offset that, meaning it has AU$4.36m net cash.

ASX:CUE Debt to Equity History March 17th 2023

How Healthy Is Cue Energy Resources' Balance Sheet?

We can see from the most recent balance sheet that Cue Energy Resources had liabilities of AU$10.4m falling due within a year, and liabilities of AU$43.3m due beyond that. Offsetting these obligations, it had cash of AU$11.3m as well as receivables valued at AU$12.2m due within 12 months. So its liabilities total AU$30.2m more than the combination of its cash and short-term receivables.

This is a mountain of leverage relative to its market capitalization of AU$40.5m. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry. Despite its noteworthy liabilities, Cue Energy Resources boasts net cash, so it's fair to say it does not have a heavy debt load!

On top of that, Cue Energy Resources grew its EBIT by 80% over the last twelve months, and that growth will make it easier to handle its debt. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Cue Energy Resources'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.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. Cue Energy Resources may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Over the last two years, Cue Energy Resources barely recorded positive free cash flow, in total. Some might say that's a concern, when it comes considering how easily it would be for it to down debt.

Summing Up

While Cue Energy Resources does have more liabilities than liquid assets, it also has net cash of AU$4.36m. And it impressed us with its EBIT growth of 80% over the last year. So we don't have any problem with Cue Energy Resources's use of debt. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. We've identified 2 warning signs with Cue Energy Resources (at least 1 which is concerning) , and understanding them should be part of your investment process.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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