Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. As with many other companies STEP Energy Services Ltd. (TSE:STEP) makes use of debt. But is this debt a concern to shareholders?
When Is Debt A Problem?
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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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.
What Is STEP Energy Services's Net Debt?
As you can see below, STEP Energy Services had CA$211.6m of debt at March 2021, down from CA$264.5m a year prior. On the flip side, it has CA$9.46m in cash leading to net debt of about CA$202.2m.
How Strong Is STEP Energy Services' Balance Sheet?
The latest balance sheet data shows that STEP Energy Services had liabilities of CA$79.3m due within a year, and liabilities of CA$217.8m falling due after that. Offsetting this, it had CA$9.46m in cash and CA$87.8m in receivables that were due within 12 months. So it has liabilities totalling CA$199.9m more than its cash and near-term receivables, combined.
The deficiency here weighs heavily on the CA$93.2m 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. After all, STEP Energy Services would likely require a major re-capitalisation if it had to pay its creditors today. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine STEP 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 STEP Energy Services had a loss before interest and tax, and actually shrunk its revenue by 55%, to CA$311m. To be frank that doesn't bode well.
While STEP Energy Services's falling revenue is about as heartwarming as a wet blanket, arguably its earnings before interest and tax (EBIT) loss is even less appealing. Indeed, it lost a very considerable CA$76m at the EBIT level. Considering that alongside the liabilities mentioned above make us nervous about the company. We'd want to see some strong near-term improvements before getting too interested in the stock. It's fair to say the loss of CA$75m didn't encourage us either; we'd like to see a profit. In the meantime, we consider the stock to be risky. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. To that end, you should be aware of the 2 warning signs we've spotted with STEP Energy Services .
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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