Health Check: How Prudently Does Cathedral Energy Services (TSE:CET) Use 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 seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. Importantly, Cathedral Energy Services Ltd. (TSE:CET) does carry debt. But the more important question is: how much risk is that debt creating?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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.

Our analysis indicates that CET is potentially undervalued!

How Much Debt Does Cathedral Energy Services Carry?

You can click the graphic below for the historical numbers, but it shows that as of June 2022 Cathedral Energy Services had CA$9.17m of debt, an increase on CA$3.30m, over one year. However, it does have CA$11.3m in cash offsetting this, leading to net cash of CA$2.14m.

How Strong Is Cathedral Energy Services' Balance Sheet?

According to the last reported balance sheet, Cathedral Energy Services had liabilities of CA$27.7m due within 12 months, and liabilities of CA$13.5m due beyond 12 months. On the other hand, it had cash of CA$11.3m and CA$24.0m worth of receivables due within a year. So it has liabilities totalling CA$5.86m more than its cash and near-term receivables, combined.

Given Cathedral Energy Services has a market capitalization of CA$272.1m, it's hard to believe these liabilities pose much threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. Despite its noteworthy liabilities, Cathedral Energy Services 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 it is future earnings, more than anything, that will determine Cathedral Energy Services's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

In the last year Cathedral Energy Services wasn't profitable at an EBIT level, but managed to grow its revenue by 240%, to CA$106m. That's virtually the hole-in-one of revenue growth!

So How Risky Is Cathedral Energy Services?

By their very nature companies that are losing money are more risky than those with a long history of profitability. And in the last year Cathedral Energy Services had an earnings before interest and tax (EBIT) loss, truth be told. And over the same period it saw negative free cash outflow of CA$12m and booked a CA$1.3m accounting loss. But the saving grace is the CA$2.14m on the balance sheet. That means it could keep spending at its current rate for more than two years. Importantly, Cathedral Energy Services's revenue growth is hot to trot. High growth pre-profit companies may well be risky, but they can also offer great rewards. 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. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for Cathedral Energy Services (of which 1 shouldn't be ignored!) you should know about.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.