Is Energy Focus (NASDAQ:EFOI) Using Debt Sensibly?

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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. We can see that Energy Focus, Inc. (NASDAQ:EFOI) does use debt in its business. But should shareholders be worried about its use of debt?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Energy Focus

How Much Debt Does Energy Focus Carry?

The image below, which you can click on for greater detail, shows that Energy Focus had debt of US$1.62m at the end of June 2023, a reduction from US$4.61m over a year. But on the other hand it also has US$1.95m in cash, leading to a US$327.0k net cash position.

How Healthy Is Energy Focus' Balance Sheet?

The latest balance sheet data shows that Energy Focus had liabilities of US$5.39m due within a year, and liabilities of US$915.0k falling due after that. Offsetting this, it had US$1.95m in cash and US$841.0k in receivables that were due within 12 months. So it has liabilities totalling US$3.52m more than its cash and near-term receivables, combined.

While this might seem like a lot, it is not so bad since Energy Focus has a market capitalization of US$7.86m, and so it could probably strengthen its balance sheet by raising capital if it needed to. However, it is still worthwhile taking a close look at its ability to pay off debt. Despite its noteworthy liabilities, Energy Focus boasts net cash, so it's fair to say it does not have a heavy debt load! The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Energy Focus can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Over 12 months, Energy Focus made a loss at the EBIT level, and saw its revenue drop to US$4.4m, which is a fall of 49%. To be frank that doesn't bode well.

So How Risky Is Energy Focus?

Statistically speaking companies that lose money are riskier than those that make money. And the fact is that over the last twelve months Energy Focus lost money at the earnings before interest and tax (EBIT) line. Indeed, in that time it burnt through US$2.7m of cash and made a loss of US$7.5m. However, it has net cash of US$327.0k, so it has a bit of time before it will need more capital. Overall, we'd say the stock is a bit risky, and we're usually very cautious until we see positive free cash flow. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. We've identified 6 warning signs with Energy Focus (at least 4 which are concerning) , and understanding them should be part of your investment process.

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. 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.