Is Centrica (LON:CNA) A Risky Investment?

Legendary fund manager Li Lu (who Charlie Munger backed) once said, '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, Centrica plc (LON:CNA) does carry debt. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. If things get really bad, the lenders can take control of the business. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Centrica

How Much Debt Does Centrica Carry?

As you can see below, Centrica had UK£3.72b of debt, at December 2023, which is about the same as the year before. You can click the chart for greater detail. But on the other hand it also has UK£6.85b in cash, leading to a UK£3.13b net cash position.

How Strong Is Centrica's Balance Sheet?

According to the last reported balance sheet, Centrica had liabilities of UK£11.1b due within 12 months, and liabilities of UK£6.00b due beyond 12 months. Offsetting these obligations, it had cash of UK£6.85b as well as receivables valued at UK£4.89b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by UK£5.40b.

This is a mountain of leverage relative to its market capitalization of UK£7.11b. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry. Despite its noteworthy liabilities, Centrica boasts net cash, so it's fair to say it does not have a heavy debt load! When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Centrica's ability to maintain a healthy balance sheet going forward. 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 Centrica wasn't profitable at an EBIT level, but managed to grow its revenue by 11%, to UK£26b. We usually like to see faster growth from unprofitable companies, but each to their own.

So How Risky Is Centrica?

While Centrica lost money on an earnings before interest and tax (EBIT) level, it actually booked a paper profit of UK£3.9b. So when you consider it has net cash, along with the statutory profit, the stock probably isn't as risky as it might seem, at least in the short term. Until we see some positive EBIT, we're a bit cautious of the stock, not least because of the rather modest revenue growth. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. These risks can be hard to spot. Every company has them, and we've spotted 3 warning signs for Centrica (of which 2 are concerning!) you should know about.

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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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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com