Health Check: How Prudently Does Genel Energy (LON:GENL) Use 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 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, Genel Energy plc (LON:GENL) does carry debt. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

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. If things get really bad, the lenders can take control of the business. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Genel Energy

What Is Genel Energy's Debt?

The image below, which you can click on for greater detail, shows that at December 2020 Genel Energy had debt of US$348.3m, up from US$297.9m in one year. However, its balance sheet shows it holds US$354.5m in cash, so it actually has US$6.20m net cash.

How Healthy Is Genel Energy's Balance Sheet?

We can see from the most recent balance sheet that Genel Energy had liabilities of US$187.1m falling due within a year, and liabilities of US$433.7m due beyond that. Offsetting this, it had US$354.5m in cash and US$48.9m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$217.4m.

While this might seem like a lot, it is not so bad since Genel Energy has a market capitalization of US$648.1m, and so it could probably strengthen its balance sheet by raising capital if it needed to. However, it is still worthwhile taking a close look at its ability to pay off debt. Despite its noteworthy liabilities, Genel Energy boasts net cash, so it's fair to say it does not have a heavy debt load! 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 Genel Energy can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Over 12 months, Genel Energy made a loss at the EBIT level, and saw its revenue drop to US$160m, which is a fall of 58%. To be frank that doesn't bode well.

So How Risky Is Genel Energy?

While Genel Energy lost money on an earnings before interest and tax (EBIT) level, it actually generated positive free cash flow US$20m. So taking that on face value, and considering the net cash situation, we don't think that the stock is too risky in the near term. Until we see some positive EBIT, we're a bit cautious of the stock, not least because of the rather modest revenue growth. 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. For example, we've discovered 1 warning sign for Genel Energy that you should be aware of before investing here.

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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