David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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 note that Photon Energy N.V. (WSE:PEN) does have debt on its balance sheet. But should shareholders be worried about its use of debt?
What Risk Does Debt Bring?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. When we examine debt levels, we first consider both cash and debt levels, together.
What Is Photon Energy's Debt?
As you can see below, at the end of December 2020, Photon Energy had €97.7m of debt, up from €80.4m a year ago. Click the image for more detail. However, it also had €9.89m in cash, and so its net debt is €87.8m.
How Strong Is Photon Energy's Balance Sheet?
The latest balance sheet data shows that Photon Energy had liabilities of €15.2m due within a year, and liabilities of €103.6m falling due after that. Offsetting this, it had €9.89m in cash and €7.17m in receivables that were due within 12 months. So it has liabilities totalling €101.8m more than its cash and near-term receivables, combined.
This deficit is considerable relative to its market capitalization of €134.9m, so it does suggest shareholders should keep an eye on Photon Energy's use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe 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 if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.
Over 12 months, Photon Energy made a loss at the EBIT level, and saw its revenue drop to €28m, which is a fall of 6.3%. We would much prefer see growth.
Importantly, Photon Energy had an earnings before interest and tax (EBIT) loss over the last year. Indeed, it lost €479k at the EBIT level. When we look at that and recall the liabilities on its balance sheet, relative to cash, it seems unwise to us for the company to have any debt. So we think its balance sheet is a little strained, though not beyond repair. However, it doesn't help that it burned through €13m of cash over the last year. So in short it's a really risky stock. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. Be aware that Photon Energy is showing 4 warning signs in our investment analysis , and 2 of those don't sit too well with us...
At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.
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