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.' 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 note that Photon Energy N.V. (WSE:PEN) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?
When Is Debt A Problem?
Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. 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, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.
How Much Debt Does Photon Energy Carry?
You can click the graphic below for the historical numbers, but it shows that as of December 2021 Photon Energy had €126.7m of debt, an increase on €97.7m, over one year. On the flip side, it has €32.5m in cash leading to net debt of about €94.2m.
How Strong Is Photon Energy's Balance Sheet?
The latest balance sheet data shows that Photon Energy had liabilities of €34.0m due within a year, and liabilities of €110.3m falling due after that. On the other hand, it had cash of €32.5m and €12.0m worth of receivables due within a year. So its liabilities total €99.8m more than the combination of its cash and short-term receivables.
When you consider that this deficiency exceeds the company's €93.2m market capitalization, you might well be inclined to review the balance sheet intently. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer extensive dilution. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Photon Energy 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.
In the last year Photon Energy wasn't profitable at an EBIT level, but managed to grow its revenue by 29%, to €36m. Shareholders probably have their fingers crossed that it can grow its way to profits.
Despite the top line growth, Photon Energy still had an earnings before interest and tax (EBIT) loss over the last year. Indeed, it lost €1.1m at the EBIT level. 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. Not least because it burned through €3.4m in negative free cash flow over the last year. That means it's on the risky side of things. 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. Be aware that Photon Energy is showing 2 warning signs in our investment analysis , and 1 of those is a bit concerning...
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.
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.