Stock Analysis
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These 4 Measures Indicate That Southern Energy (CVE:SOU) Is Using Debt Reasonably Well
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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. Importantly, Southern Energy Corp. (CVE:SOU) does carry debt. But should shareholders be worried about its use of debt?
When Is Debt A Problem?
Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. If things get really bad, the lenders can take control of the business. 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 step when considering a company's debt levels is to consider its cash and debt together.
See our latest analysis for Southern Energy
What Is Southern Energy's Net Debt?
The image below, which you can click on for greater detail, shows that Southern Energy had debt of US$7.22m at the end of December 2022, a reduction from US$9.80m over a year. But it also has US$28.4m in cash to offset that, meaning it has US$21.1m net cash.
A Look At Southern Energy's Liabilities
Zooming in on the latest balance sheet data, we can see that Southern Energy had liabilities of US$17.4m due within 12 months and liabilities of US$12.8m due beyond that. On the other hand, it had cash of US$28.4m and US$3.74m worth of receivables due within a year. So it can boast US$1.84m more liquid assets than total liabilities.
This short term liquidity is a sign that Southern Energy could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, Southern Energy boasts net cash, so it's fair to say it does not have a heavy debt load!
In addition to that, we're happy to report that Southern Energy has boosted its EBIT by 50%, thus reducing the spectre of future debt repayments. 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 Southern Energy'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.
Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Southern Energy may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Over the last two years, Southern Energy saw substantial negative free cash flow, in total. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.
Summing Up
While we empathize with investors who find debt concerning, you should keep in mind that Southern Energy has net cash of US$21.1m, as well as more liquid assets than liabilities. And we liked the look of last year's 50% year-on-year EBIT growth. So we are not troubled with Southern Energy's debt use. 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. Be aware that Southern Energy is showing 4 warning signs in our investment analysis , and 2 of those can't be ignored...
If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.
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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.
About TSXV:SOU
Southern Energy
Operates as an oil and natural gas exploration and production company in Canada.