Is Centrica (LON:CNA) Using Too Much Debt?

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.' 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, Centrica plc (LON:CNA) 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. 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 examine debt levels, we first consider both cash and debt levels, together.

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What Is Centrica's Net Debt?

You can click the graphic below for the historical numbers, but it shows that Centrica had UK£3.51b of debt in June 2022, down from UK£3.68b, one year before. However, it does have UK£4.09b in cash offsetting this, leading to net cash of UK£580.0m.

How Healthy Is Centrica's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Centrica had liabilities of UK£21.0b due within 12 months and liabilities of UK£7.50b due beyond that. Offsetting these obligations, it had cash of UK£4.09b as well as receivables valued at UK£4.38b due within 12 months. So its liabilities total UK£20.1b more than the combination of its cash and short-term receivables.

This deficit casts a shadow over the UK£4.58b company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. At the end of the day, Centrica would probably need a major re-capitalization if its creditors were to demand repayment. Given that Centrica has more cash than debt, we're pretty confident it can handle its debt, despite the fact that it has a lot of liabilities in total. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Centrica 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 Centrica wasn't profitable at an EBIT level, but managed to grow its revenue by 41%, to UK£18b. With any luck the company will be able to grow its way to profitability.

So How Risky Is Centrica?

While Centrica lost money on an earnings before interest and tax (EBIT) level, it actually generated positive free cash flow UK£749m. 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. The saving grace for the stock is the strong revenue growth of 41% over the last twelve months. But we genuinely do think the balance sheet is a risky. 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. Be aware that Centrica is showing 2 warning signs in our investment analysis , and 1 of those makes us a bit uncomfortable...

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.