We Think Empress Royalty (CVE:EMPR) Is Taking Some Risk With Its Debt

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.' 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. As with many other companies Empress Royalty Corp. (CVE:EMPR) makes use of debt. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

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. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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 Empress Royalty

What Is Empress Royalty's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of December 2024 Empress Royalty had US$5.17m of debt, an increase on US$2.94m, over one year. However, it does have US$953.6k in cash offsetting this, leading to net debt of about US$4.22m.

How Healthy Is Empress Royalty's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Empress Royalty had liabilities of US$3.61m due within 12 months and liabilities of US$2.55m due beyond that. Offsetting these obligations, it had cash of US$953.6k as well as receivables valued at US$401.1k due within 12 months. So its liabilities total US$4.80m more than the combination of its cash and short-term receivables.

Of course, Empress Royalty has a market capitalization of US$30.5m, so these liabilities are probably manageable. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Given net debt is only 1.0 times EBITDA, it is initially surprising to see that Empress Royalty's EBIT has low interest coverage of 1.8 times. So one way or the other, it's clear the debt levels are not trivial. Notably, Empress Royalty made a loss at the EBIT level, last year, but improved that to positive EBIT of US$2.6m in the last twelve months. 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 Empress Royalty'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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So it is important to check how much of its earnings before interest and tax (EBIT) converts to actual free cash flow. Over the last year, Empress Royalty 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.

Our View

Both Empress Royalty's conversion of EBIT to free cash flow and its interest cover were discouraging. At least its net debt to EBITDA gives us reason to be optimistic. When we consider all the factors discussed, it seems to us that Empress Royalty is taking some risks with its use of debt. So while that leverage does boost returns on equity, we wouldn't really want to see it increase from here. 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 Empress Royalty is showing 1 warning sign in our investment analysis , you should know about...

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.