Is Pieridae Energy (TSE:PEA) Using Too Much Debt?

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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. As with many other companies Pieridae Energy Limited (TSE:PEA) makes use of 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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for Pieridae Energy

How Much Debt Does Pieridae Energy Carry?

The image below, which you can click on for greater detail, shows that at December 2020 Pieridae Energy had debt of CA$219.6m, up from CA$202.9m in one year. However, it does have CA$11.1m in cash offsetting this, leading to net debt of about CA$208.5m.

A Look At Pieridae Energy's Liabilities

According to the last reported balance sheet, Pieridae Energy had liabilities of CA$106.8m due within 12 months, and liabilities of CA$501.4m due beyond 12 months. Offsetting this, it had CA$11.1m in cash and CA$44.9m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CA$552.3m.

The deficiency here weighs heavily on the CA$67.0m company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we'd watch its balance sheet closely, without a doubt. At the end of the day, Pieridae Energy would probably need a major re-capitalization if its creditors were to demand repayment. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Pieridae Energy can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

In the last year Pieridae Energy wasn't profitable at an EBIT level, but managed to grow its revenue by 131%, to CA$257m. So its pretty obvious shareholders are hoping for more growth!

Caveat Emptor

Even though Pieridae Energy managed to grow its top line quite deftly, the cold hard truth is that it is losing money on the EBIT line. Indeed, it lost a very considerable CA$49m at the EBIT level. When you combine this with the very significant balance sheet liabilities mentioned above, we are so wary of it that we are basically at a loss for the right words. Sure, the company might have a nice story about how they are going on to a brighter future. But the reality is that it is low on liquid assets relative to liabilities, and it burned through CA$16m in the last year. So is this a high risk stock? We think so, and we'd avoid it. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. These risks can be hard to spot. Every company has them, and we've spotted 4 warning signs for Pieridae Energy (of which 1 is a bit unpleasant!) you should know about.

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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