Is Karma Energy (NSE:KARMAENG) Weighed On By Its Debt Load?

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.' 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 can see that Karma Energy Limited (NSE:KARMAENG) does use debt in its business. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Karma Energy

What Is Karma Energy's Debt?

As you can see below, Karma Energy had ₹911.8m of debt, at September 2020, which is about the same as the year before. You can click the chart for greater detail. However, it does have ₹105.7m in cash offsetting this, leading to net debt of about ₹806.1m.

A Look At Karma Energy's Liabilities

Zooming in on the latest balance sheet data, we can see that Karma Energy had liabilities of ₹746.3m due within 12 months and liabilities of ₹333.8m due beyond that. On the other hand, it had cash of ₹105.7m and ₹116.8m worth of receivables due within a year. So its liabilities total ₹857.6m more than the combination of its cash and short-term receivables.

This deficit casts a shadow over the ₹194.7m company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. At the end of the day, Karma Energy would probably need a major re-capitalization if its creditors were to demand repayment. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Karma Energy'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.

Over 12 months, Karma Energy made a loss at the EBIT level, and saw its revenue drop to ₹322m, which is a fall of 18%. We would much prefer see growth.

Caveat Emptor

Not only did Karma Energy's revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). Indeed, it lost ₹6.1m at the EBIT level. Combining this information with the significant liabilities we already touched on makes us very hesitant about this stock, to say the least. That said, it is possible that the company will turn its fortunes around. But we think that is unlikely since it is low on liquid assets, and made a loss of ₹59m in the last year. So while it's not wise to assume the company will fail, we do think it's 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. Consider for instance, the ever-present spectre of investment risk. We've identified 4 warning signs with Karma Energy (at least 2 which are potentially serious) , and understanding them should be part of your investment process.

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.

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