Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We can see that Crown Point Energy Inc. (CVE:CWV) does use debt in its business. But is this debt a concern to shareholders?
What Risk Does Debt Bring?
Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. When we think about a company's use of debt, we first look at cash and debt together.
What Is Crown Point Energy's Net Debt?
You can click the graphic below for the historical numbers, but it shows that as of June 2021 Crown Point Energy had US$5.77m of debt, an increase on US$1.21m, over one year. However, it also had US$1.68m in cash, and so its net debt is US$4.09m.
A Look At Crown Point Energy's Liabilities
According to the last reported balance sheet, Crown Point Energy had liabilities of US$3.79m due within 12 months, and liabilities of US$20.6m due beyond 12 months. Offsetting this, it had US$1.68m in cash and US$3.80m in receivables that were due within 12 months. So its liabilities total US$18.9m more than the combination of its cash and short-term receivables.
Given this deficit is actually higher than the company's market capitalization of US$17.3m, we think shareholders really should watch Crown Point Energy's debt levels, like a parent watching their child ride a bike for the first time. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer extensive dilution. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Crown Point Energy's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.
In the last year Crown Point Energy had a loss before interest and tax, and actually shrunk its revenue by 11%, to US$15m. We would much prefer see growth.
While Crown Point Energy'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 US$1.5m at the EBIT level. When we look at that alongside the significant liabilities, we're not particularly confident about the company. We'd want to see some strong near-term improvements before getting too interested in the stock. But on the bright side the company actually produced a statutory profit of US$4.3m and free cash flow of US$319k. So there is definitely a chance that it can improve things in the next few years. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. For example Crown Point Energy has 3 warning signs (and 1 which is concerning) 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.
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