The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We can see that BGR Energy Systems Limited (NSE:BGRENERGY) does use debt in its business. But the real question is whether this debt is making the company risky.
When Is Debt A Problem?
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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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.
What Is BGR Energy Systems's Net Debt?
The image below, which you can click on for greater detail, shows that BGR Energy Systems had debt of ₹19.4b at the end of March 2021, a reduction from ₹21.4b over a year. However, it also had ₹3.54b in cash, and so its net debt is ₹15.9b.
A Look At BGR Energy Systems' Liabilities
We can see from the most recent balance sheet that BGR Energy Systems had liabilities of ₹43.6b falling due within a year, and liabilities of ₹2.94b due beyond that. Offsetting this, it had ₹3.54b in cash and ₹33.7b in receivables that were due within 12 months. So it has liabilities totalling ₹9.24b more than its cash and near-term receivables, combined.
This deficit casts a shadow over the ₹3.88b company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. After all, BGR Energy Systems would likely require a major re-capitalisation if it had to pay its creditors today. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since BGR Energy Systems will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.
Over 12 months, BGR Energy Systems made a loss at the EBIT level, and saw its revenue drop to ₹13b, which is a fall of 42%. That makes us nervous, to say the least.
While BGR Energy Systems's falling revenue is about as heartwarming as a wet blanket, arguably its earnings before interest and tax (EBIT) loss is even less appealing. Its EBIT loss was a whopping ₹2.6b. When we look at that alongside the significant liabilities, we're not particularly confident about the company. We'd want to see some strong near-term improvements before getting too interested in the stock. For example, we would not want to see a repeat of last year's loss of ₹3.9b. In the meantime, we consider the stock to be risky. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. We've identified 3 warning signs with BGR Energy Systems (at least 1 which is potentially serious) , and understanding them should be part of your investment process.
If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.
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