Is Questerre Energy (TSE:QEC) 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.' 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, Questerre Energy Corporation (TSE:QEC) does carry debt. But should shareholders be worried about its use of debt?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Questerre Energy

What Is Questerre Energy's Debt?

The image below, which you can click on for greater detail, shows that Questerre Energy had debt of CA$7.42m at the end of September 2021, a reduction from CA$16.2m over a year. But it also has CA$10.5m in cash to offset that, meaning it has CA$3.12m net cash.

How Strong Is Questerre Energy's Balance Sheet?

We can see from the most recent balance sheet that Questerre Energy had liabilities of CA$12.7m falling due within a year, and liabilities of CA$21.0m due beyond that. On the other hand, it had cash of CA$10.5m and CA$3.45m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by CA$19.8m.

While this might seem like a lot, it is not so bad since Questerre Energy has a market capitalization of CA$66.4m, and so it could probably strengthen its balance sheet by raising capital if it needed to. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. Despite its noteworthy liabilities, Questerre Energy boasts net cash, so it's fair to say it does not have a heavy debt load!

It was also good to see that despite losing money on the EBIT line last year, Questerre Energy turned things around in the last 12 months, delivering and EBIT of CA$5.5m. 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 Questerre Energy'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.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. Questerre Energy may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Over the last year, Questerre Energy actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Summing up

While Questerre Energy does have more liabilities than liquid assets, it also has net cash of CA$3.12m. The cherry on top was that in converted 174% of that EBIT to free cash flow, bringing in CA$9.5m. So we don't think Questerre Energy's use of debt is risky. 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 be aware of the 2 warning signs we've spotted with Questerre Energy .

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. 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.