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

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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. Importantly, Empire Energy Group Limited (ASX:EEG) does carry debt. But is this debt a concern to shareholders?

When Is Debt Dangerous?

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. If things get really bad, the lenders can take control of the business. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for Empire Energy Group

What Is Empire Energy Group's Net Debt?

You can click the graphic below for the historical numbers, but it shows that Empire Energy Group had AU$7.82m of debt in December 2020, down from AU$9.23m, one year before. However, it does have AU$14.6m in cash offsetting this, leading to net cash of AU$6.80m.

How Healthy Is Empire Energy Group's Balance Sheet?

We can see from the most recent balance sheet that Empire Energy Group had liabilities of AU$14.3m falling due within a year, and liabilities of AU$22.1m due beyond that. Offsetting these obligations, it had cash of AU$14.6m as well as receivables valued at AU$2.54m due within 12 months. So its liabilities total AU$19.2m more than the combination of its cash and short-term receivables.

Since publicly traded Empire Energy Group shares are worth a total of AU$116.6m, it seems unlikely that this level of liabilities would be a major threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. While it does have liabilities worth noting, Empire Energy Group also has more cash than debt, so we're pretty confident it can manage its debt safely. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Empire Energy Group's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Over 12 months, Empire Energy Group made a loss at the EBIT level, and saw its revenue drop to AU$6.5m, which is a fall of 16%. That's not what we would hope to see.

So How Risky Is Empire Energy Group?

Statistically speaking companies that lose money are riskier than those that make money. And we do note that Empire Energy Group had an earnings before interest and tax (EBIT) loss, over the last year. Indeed, in that time it burnt through AU$16m of cash and made a loss of AU$7.7m. While this does make the company a bit risky, it's important to remember it has net cash of AU$6.80m. That kitty means the company can keep spending for growth for at least two years, at current rates. Summing up, we're a little skeptical of this one, as it seems fairly risky in the absence of free cashflow. 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 example - Empire Energy Group has 5 warning signs we think you should be aware of.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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This article by Simply Wall St is general in nature. 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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