Here's Why Geo Energy Resources (SGX:RE4) Can Manage Its Debt Responsibly

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. As with many other companies Geo Energy Resources Limited (SGX:RE4) makes use of debt. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

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. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Geo Energy Resources

What Is Geo Energy Resources's Net Debt?

You can click the graphic below for the historical numbers, but it shows that Geo Energy Resources had US$58.8m of debt in December 2020, down from US$277.3m, one year before. However, its balance sheet shows it holds US$72.8m in cash, so it actually has US$14.0m net cash.

A Look At Geo Energy Resources' Liabilities

Zooming in on the latest balance sheet data, we can see that Geo Energy Resources had liabilities of US$79.6m due within 12 months and liabilities of US$73.8m due beyond that. Offsetting these obligations, it had cash of US$72.8m as well as receivables valued at US$53.0m due within 12 months. So its liabilities total US$27.7m more than the combination of its cash and short-term receivables.

Given Geo Energy Resources has a market capitalization of US$178.6m, it's hard to believe these liabilities pose much threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. Despite its noteworthy liabilities, Geo Energy Resources boasts net cash, so it's fair to say it does not have a heavy debt load!

We also note that Geo Energy Resources improved its EBIT from a last year's loss to a positive US$12m. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Geo Energy Resources 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Geo Energy Resources has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Happily for any shareholders, Geo Energy Resources actually produced more free cash flow than EBIT over the last year. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Summing up

Although Geo Energy Resources's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of US$14.0m. The cherry on top was that in converted 382% of that EBIT to free cash flow, bringing in US$46m. So we are not troubled with Geo Energy Resources's debt use. 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. For instance, we've identified 2 warning signs for Geo Energy Resources (1 makes us a bit uncomfortable) you should be aware of.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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This article by Simply Wall St is general in nature. 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.
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