Health Check: How Prudently Does Energean (LON:ENOG) Use Debt?

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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. Importantly, Energean plc (LON:ENOG) does carry debt. But is this debt a concern to shareholders?

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. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for Energean

What Is Energean's Net Debt?

The image below, which you can click on for greater detail, shows that at December 2020 Energean had debt of US$1.44b, up from US$916.0m in one year. However, it does have US$241.7m in cash offsetting this, leading to net debt of about US$1.20b.

How Strong Is Energean's Balance Sheet?

According to the last reported balance sheet, Energean had liabilities of US$1.48b due within 12 months, and liabilities of US$1.47b due beyond 12 months. Offsetting these obligations, it had cash of US$241.7m as well as receivables valued at US$279.1m due within 12 months. So its liabilities total US$2.42b more than the combination of its cash and short-term receivables.

Given this deficit is actually higher than the company's market capitalization of US$2.04b, we think shareholders really should watch Energean's debt levels, like a parent watching their child ride a bike for the first time. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer extensive dilution. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Energean 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 Energean had a loss before interest and tax, and actually shrunk its revenue by 63%, to US$28m. That makes us nervous, to say the least.

Caveat Emptor

Not only did Energean's revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). Indeed, it lost US$106m at the EBIT level. Considering that alongside the liabilities mentioned above make us nervous about the company. It would need to improve its operations quickly for us to be interested in it. Not least because it had negative free cash flow of US$418m over the last twelve months. That means it's on the risky side of things. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For example - Energean has 1 warning sign we think you should be aware of.

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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