Is PHX Energy Services (TSE:PHX) A Risky Investment?

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. We can see that PHX Energy Services Corp. (TSE:PHX) does use debt in its business. But the real question is whether this debt is making the company risky.

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What Risk Does Debt Bring?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

How Much Debt Does PHX Energy Services Carry?

As you can see below, at the end of December 2024, PHX Energy Services had CA$16.8m of debt, up from CA$7.56m a year ago. Click the image for more detail. However, because it has a cash reserve of CA$14.2m, its net debt is less, at about CA$2.66m.

How Healthy Is PHX Energy Services' Balance Sheet?

According to the last reported balance sheet, PHX Energy Services had liabilities of CA$129.5m due within 12 months, and liabilities of CA$71.6m due beyond 12 months. On the other hand, it had cash of CA$14.2m and CA$134.1m worth of receivables due within a year. So it has liabilities totalling CA$52.8m more than its cash and near-term receivables, combined.

Of course, PHX Energy Services has a market capitalization of CA$347.1m, so these liabilities are probably manageable. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. But either way, PHX Energy Services has virtually no net debt, so it's fair to say it does not have a heavy debt load!

View our latest analysis for PHX Energy Services

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

With debt at a measly 0.028 times EBITDA and EBIT covering interest a whopping 12.2 times, it's clear that PHX Energy Services is not a desperate borrower. Indeed relative to its earnings its debt load seems light as a feather. The modesty of its debt load may become crucial for PHX Energy Services if management cannot prevent a repeat of the 33% cut to EBIT over the last year. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if PHX Energy Services 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 .

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So we always check how much of that EBIT is translated into free cash flow. In the last three years, PHX Energy Services created free cash flow amounting to 2.9% of its EBIT, an uninspiring performance. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.

Our View

We feel some trepidation about PHX Energy Services's difficulty EBIT growth rate, but we've got positives to focus on, too. To wit both its interest cover and net debt to EBITDA were encouraging signs. Looking at all the angles mentioned above, it does seem to us that PHX Energy Services is a somewhat risky investment as a result of its debt. Not all risk is bad, as it can boost share price returns if it pays off, but this debt risk is worth keeping in mind. 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. To that end, you should learn about the 3 warning signs we've spotted with PHX Energy Services (including 1 which shouldn't be ignored) .

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.