Is NuEnergy Gas (ASX:NGY) 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. As with many other companies NuEnergy Gas Limited (ASX:NGY) makes use of debt. But is this debt a concern to shareholders?

When Is Debt Dangerous?

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. 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for NuEnergy Gas

How Much Debt Does NuEnergy Gas Carry?

The image below, which you can click on for greater detail, shows that at June 2020 NuEnergy Gas had debt of AU$3.27m, up from AU$2.24m in one year. However, it also had AU$337.5k in cash, and so its net debt is AU$2.93m.

A Look At NuEnergy Gas's Liabilities

According to the balance sheet data, NuEnergy Gas had liabilities of AU$14.8m due within 12 months, but no longer term liabilities. Offsetting these obligations, it had cash of AU$337.5k as well as receivables valued at AU$105.0k due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by AU$14.4m.

This deficit is considerable relative to its market capitalization of AU$17.8m, so it does suggest shareholders should keep an eye on NuEnergy Gas's use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution. 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 NuEnergy Gas 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.

Given its lack of meaningful operating revenue, NuEnergy Gas shareholders no doubt hope it can fund itself until it can sell some combustibles.

Caveat Emptor

Not only did NuEnergy Gas's revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). Indeed, it lost a very considerable AU$2.0m at the EBIT level. 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. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. Another cause for caution is that is bled AU$771k in negative free cash flow over the last twelve months. So suffice it to say we do consider the stock to be risky. 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. Consider for instance, the ever-present spectre of investment risk. We've identified 5 warning signs with NuEnergy Gas (at least 2 which are a bit concerning) , and understanding them should be part of your investment process.

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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