Is Southern Energy (CVE:SOU) Using Debt In A Risky Way?

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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, Southern Energy Corp. (CVE:SOU) does carry debt. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Southern Energy

What Is Southern Energy's Debt?

The image below, which you can click on for greater detail, shows that at March 2024 Southern Energy had debt of US$21.4m, up from US$8.96m in one year. However, because it has a cash reserve of US$1.84m, its net debt is less, at about US$19.5m.

How Healthy Is Southern Energy's Balance Sheet?

According to the last reported balance sheet, Southern Energy had liabilities of US$14.7m due within 12 months, and liabilities of US$24.3m due beyond 12 months. On the other hand, it had cash of US$1.84m and US$1.47m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$35.7m.

This deficit casts a shadow over the US$19.5m company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. After all, Southern Energy would likely require a major re-capitalisation if it had to pay its creditors today. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Southern Energy will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Over 12 months, Southern Energy made a loss at the EBIT level, and saw its revenue drop to US$15m, which is a fall of 56%. To be frank that doesn't bode well.

Caveat Emptor

Not only did Southern Energy's revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). Indeed, it lost a very considerable US$47m 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. Not least because it burned through US$4.4m in negative free cash flow over the last year. That means it's on the risky side of things. 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. Be aware that Southern Energy is showing 3 warning signs in our investment analysis , and 1 of those is a bit unpleasant...

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.