Is Zephyr Energy (LON:ZPHR) A Risky Investment?

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.' 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. Importantly, Zephyr Energy plc (LON:ZPHR) does carry debt. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Zephyr Energy

What Is Zephyr Energy's Net Debt?

You can click the graphic below for the historical numbers, but it shows that Zephyr Energy had US$29.2m of debt in June 2024, down from US$33.7m, one year before. However, because it has a cash reserve of US$1.09m, its net debt is less, at about US$28.1m.

How Strong Is Zephyr Energy's Balance Sheet?

The latest balance sheet data shows that Zephyr Energy had liabilities of US$28.4m due within a year, and liabilities of US$13.9m falling due after that. Offsetting these obligations, it had cash of US$1.09m as well as receivables valued at US$11.5m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$29.7m.

Zephyr Energy has a market capitalization of US$80.5m, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. 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 Zephyr 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.

In the last year Zephyr Energy had a loss before interest and tax, and actually shrunk its revenue by 10%, to US$23m. That's not what we would hope to see.

Caveat Emptor

While Zephyr Energy's falling revenue is about as heartwarming as a wet blanket, arguably its earnings before interest and tax (EBIT) loss is even less appealing. Indeed, it lost US$1.8m at the EBIT level. Considering that alongside the liabilities mentioned above does not give us much confidence that company should be using so much debt. So we think its balance sheet is a little strained, though not beyond repair. Another cause for caution is that is bled US$11m in negative free cash flow over the last twelve months. So suffice it to say we consider the stock very risky. 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. These risks can be hard to spot. Every company has them, and we've spotted 4 warning signs for Zephyr Energy (of which 1 is concerning!) you should know about.

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.