Is Egdon Resources (LON:EDR) A Risky Investment?

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.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We note that Egdon Resources plc (LON:EDR) does have debt on its balance sheet. 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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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 step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Egdon Resources

What Is Egdon Resources's Net Debt?

As you can see below, at the end of January 2021, Egdon Resources had UK£1.98m of debt, up from none a year ago. Click the image for more detail. However, its balance sheet shows it holds UK£2.42m in cash, so it actually has UK£440.0k net cash.

How Strong Is Egdon Resources' Balance Sheet?

The latest balance sheet data shows that Egdon Resources had liabilities of UK£3.27m due within a year, and liabilities of UK£4.77m falling due after that. On the other hand, it had cash of UK£2.42m and UK£719.0k worth of receivables due within a year. So it has liabilities totalling UK£4.90m more than its cash and near-term receivables, combined.

This deficit is considerable relative to its market capitalization of UK£5.58m, so it does suggest shareholders should keep an eye on Egdon Resources' use of debt. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry. While it does have liabilities worth noting, Egdon Resources also has more cash than debt, so we're pretty confident it can manage its debt safely. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Egdon Resources can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

In the last year Egdon Resources had a loss before interest and tax, and actually shrunk its revenue by 57%, to UK£713k. That makes us nervous, to say the least.

So How Risky Is Egdon Resources?

By their very nature companies that are losing money are more risky than those with a long history of profitability. And we do note that Egdon Resources had an earnings before interest and tax (EBIT) loss, over the last year. Indeed, in that time it burnt through UK£913k of cash and made a loss of UK£2.6m. With only UK£440.0k on the balance sheet, it would appear that its going to need to raise capital again soon. Overall, we'd say the stock is a bit risky, and we're usually very cautious until we see positive free cash flow. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. We've identified 4 warning signs with Egdon Resources (at least 2 which can't be ignored) , and understanding them should be part of your investment process.

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. 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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