Is Empire Energy Group (ASX:EEG) Using Debt Sensibly?

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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We can see that Empire Energy Group Limited (ASX:EEG) does use debt in its business. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. 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. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Empire Energy Group

How Much Debt Does Empire Energy Group Carry?

The image below, which you can click on for greater detail, shows that at June 2023 Empire Energy Group had debt of AU$15.1m, up from AU$8.09m in one year. However, its balance sheet shows it holds AU$19.6m in cash, so it actually has AU$4.54m net cash.

How Healthy Is Empire Energy Group's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Empire Energy Group had liabilities of AU$23.7m due within 12 months and liabilities of AU$37.5m due beyond that. On the other hand, it had cash of AU$19.6m and AU$1.32m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by AU$40.3m.

This deficit isn't so bad because Empire Energy Group is worth AU$154.6m, 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. Despite its noteworthy liabilities, Empire Energy Group boasts net cash, so it's fair to say it does not have a heavy debt load! The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Empire Energy Group can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Over 12 months, Empire Energy Group made a loss at the EBIT level, and saw its revenue drop to AU$11m, which is a fall of 8.2%. That's not what we would hope to see.

So How Risky Is Empire Energy Group?

By their very nature companies that are losing money are more risky than those with a long history of profitability. And we do note that Empire Energy Group had an earnings before interest and tax (EBIT) loss, over the last year. And over the same period it saw negative free cash outflow of AU$35m and booked a AU$12m accounting loss. But the saving grace is the AU$4.54m on the balance sheet. That means it could keep spending at its current rate for more than two years. Summing up, we're a little skeptical of this one, as it seems fairly risky in the absence of free cashflow. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. For example Empire Energy Group has 2 warning signs (and 1 which doesn't sit too well with us) we think you should know about.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.