Is Africa Energy (CVE:AFE) A Risky Investment?

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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. We can see that Africa Energy Corp. (CVE:AFE) does use debt in its business. But is this debt a concern to shareholders?

When Is Debt Dangerous?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Africa Energy

What Is Africa Energy's Debt?

As you can see below, at the end of March 2024, Africa Energy had US$7.40m of debt, up from US$5.00m a year ago. Click the image for more detail. However, because it has a cash reserve of US$1.62m, its net debt is less, at about US$5.78m.

How Strong Is Africa Energy's Balance Sheet?

According to the balance sheet data, Africa Energy had liabilities of US$7.71m due within 12 months, but no longer term liabilities. On the other hand, it had cash of US$1.62m and US$72.0k worth of receivables due within a year. So it has liabilities totalling US$6.02m more than its cash and near-term receivables, combined.

Since publicly traded Africa Energy shares are worth a total of US$92.3m, it seems unlikely that this level of liabilities would be a major threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Africa Energy's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Given its lack of meaningful operating revenue, Africa Energy shareholders no doubt hope it can fund itself until it can sell some combustibles.

Caveat Emptor

Importantly, Africa Energy had an earnings before interest and tax (EBIT) loss over the last year. Indeed, it lost US$3.3m at the EBIT level. When we look at that and recall the liabilities on its balance sheet, relative to cash, it seems unwise to us for the company to have any debt. So we think its balance sheet is a little strained, though not beyond repair. However, it doesn't help that it burned through US$1.4m of cash over the last year. So suffice it to say we do consider the stock to be 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. For example Africa Energy has 5 warning signs (and 2 which are significant) we think you should know about.

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.