We Think Geo Energy Resources (SGX:RE4) Can Stay On Top Of Its Debt

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.' 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. Importantly, Geo Energy Resources Limited (SGX:RE4) does carry debt. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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.

See 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$58.9m of debt in March 2021, down from US$183.8m, one year before. However, its balance sheet shows it holds US$82.0m in cash, so it actually has US$23.1m net cash.

How Strong Is Geo Energy Resources' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Geo Energy Resources had liabilities of US$73.7m due within 12 months and liabilities of US$77.2m due beyond that. Offsetting this, it had US$82.0m in cash and US$46.4m in receivables that were due within 12 months. So it has liabilities totalling US$22.5m more than its cash and near-term receivables, combined.

Of course, Geo Energy Resources has a market capitalization of US$267.7m, so these liabilities are probably manageable. 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!

Notably, Geo Energy Resources made a loss at the EBIT level, last year, but improved that to positive EBIT of US$49m in the last twelve months. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Geo 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Geo Energy Resources may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Over the last year, Geo Energy Resources actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Summing up

While it is always sensible to look at a company's total liabilities, it is very reassuring that Geo Energy Resources has US$23.1m in net cash. The cherry on top was that in converted 110% of that EBIT to free cash flow, bringing in US$54m. So we don't have any problem with Geo Energy Resources's use of debt. 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. For example, we've discovered 3 warning signs for Geo Energy Resources that you should be aware of before investing here.

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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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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