Is Deep Energy Resources (NSE:DEEPENR) Using Too Much 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. We note that Deep Energy Resources Limited (NSE:DEEPENR) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

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. 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.

View our latest analysis for Deep Energy Resources

How Much Debt Does Deep Energy Resources Carry?

As you can see below, at the end of September 2022, Deep Energy Resources had ₹348.7m of debt, up from ₹16.9m a year ago. Click the image for more detail. However, because it has a cash reserve of ₹23.7m, its net debt is less, at about ₹325.0m.

How Strong Is Deep Energy Resources' Balance Sheet?

According to the last reported balance sheet, Deep Energy Resources had liabilities of ₹1.24b due within 12 months, and liabilities of ₹400.7m due beyond 12 months. On the other hand, it had cash of ₹23.7m and ₹17.2m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₹1.60b.

While this might seem like a lot, it is not so bad since Deep Energy Resources has a market capitalization of ₹3.73b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

As it happens Deep Energy Resources has a fairly concerning net debt to EBITDA ratio of 14.8 but very strong interest coverage of 39.3. This means that unless the company has access to very cheap debt, that interest expense will likely grow in the future. It is well worth noting that Deep Energy Resources's EBIT shot up like bamboo after rain, gaining 84% in the last twelve months. That'll make it easier to manage its debt. There's no doubt that we learn most about debt from the balance sheet. But it is Deep Energy Resources's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. During the last three years, Deep Energy Resources burned a lot of cash. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Our View

While Deep Energy Resources's conversion of EBIT to free cash flow has us nervous. For example, its interest cover and EBIT growth rate give us some confidence in its ability to manage its debt. We think that Deep Energy Resources's debt does make it a bit risky, after considering the aforementioned data points together. Not all risk is bad, as it can boost share price returns if it pays off, but this debt risk is worth keeping in mind. 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 Deep Energy Resources has 3 warning signs (and 2 which make us uncomfortable) we think you should know about.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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

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.