Is Penneo (CPH:PENNEO) Using Debt Sensibly?

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a 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, Penneo A/S (CPH:PENNEO) does carry debt. But the real question is whether this debt is making the company risky.

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. 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. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Penneo

What Is Penneo's Net Debt?

The image below, which you can click on for greater detail, shows that at December 2021 Penneo had debt of kr.14.7m, up from kr.5.07m in one year. However, it does have kr.25.4m in cash offsetting this, leading to net cash of kr.10.7m.

How Healthy Is Penneo's Balance Sheet?

We can see from the most recent balance sheet that Penneo had liabilities of kr.18.6m falling due within a year, and liabilities of kr.28.8m due beyond that. Offsetting this, it had kr.25.4m in cash and kr.16.6m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by kr.5.41m.

Having regard to Penneo's size, it seems that its liquid assets are well balanced with its total liabilities. So it's very unlikely that the kr.486.9m company is short on cash, but still worth keeping an eye on the balance sheet. While it does have liabilities worth noting, Penneo also has more cash than debt, so we're pretty confident it can manage its debt safely. 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 Penneo'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.

In the last year Penneo wasn't profitable at an EBIT level, but managed to grow its revenue by 53%, to kr.54m. With any luck the company will be able to grow its way to profitability.

So How Risky Is Penneo?

We have no doubt that loss making companies are, in general, riskier than profitable ones. And the fact is that over the last twelve months Penneo lost money at the earnings before interest and tax (EBIT) line. And over the same period it saw negative free cash outflow of kr.24m and booked a kr.19m accounting loss. With only kr.10.7m on the balance sheet, it would appear that its going to need to raise capital again soon. Penneo's revenue growth shone bright over the last year, so it may well be in a position to turn a profit in due course. Pre-profit companies are often risky, but they can also offer great rewards. 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. Case in point: We've spotted 3 warning signs for Penneo you should be aware of.

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.