Is Africa Energy (CVE:AFE) Using Too Much Debt?

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. We can see that Africa Energy Corp. (CVE:AFE) does use debt in its business. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. 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. 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.

View our latest analysis for Africa Energy

What Is Africa Energy's Debt?

You can click the graphic below for the historical numbers, but it shows that as of March 2023 Africa Energy had US$5.00m of debt, an increase on none, over one year. However, it also had US$2.66m in cash, and so its net debt is US$2.34m.

How Healthy Is Africa Energy's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Africa Energy had liabilities of US$5.89m due within 12 months and no liabilities due beyond that. Offsetting this, it had US$2.66m in cash and US$47.0k in receivables that were due within 12 months. So its liabilities total US$3.18m more than the combination of its cash and short-term receivables.

Given Africa Energy has a market capitalization of US$133.6m, it's hard to believe these liabilities pose much threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. 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 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.

Since Africa Energy doesn't have significant operating revenue, shareholders must hope it'll sell some fossil fuels, before it runs out of money.

Caveat Emptor

Importantly, Africa Energy had an earnings before interest and tax (EBIT) loss over the last year. Indeed, it lost a very considerable US$20m 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$11m of cash over the last year. So in short it's a really risky stock. 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 4 warning signs (and 2 which make us uncomfortable) 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.