Zeo Energy (NASDAQ:ZEO) Seems To Use Debt Quite Sensibly

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.' 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. Importantly, Zeo Energy Corp. (NASDAQ:ZEO) does carry debt. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. If things get really bad, the lenders can take control of the business. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Zeo Energy

How Much Debt Does Zeo Energy Carry?

As you can see below, at the end of December 2023, Zeo Energy had US$1.79m of debt, up from US$1.05m a year ago. Click the image for more detail. But on the other hand it also has US$8.02m in cash, leading to a US$6.23m net cash position.

How Strong Is Zeo Energy's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Zeo Energy had liabilities of US$13.6m due within 12 months and liabilities of US$2.03m due beyond that. Offsetting this, it had US$8.02m in cash and US$2.97m in receivables that were due within 12 months. So it has liabilities totalling US$4.66m more than its cash and near-term receivables, combined.

Given Zeo Energy has a market capitalization of US$202.9m, it's hard to believe these liabilities pose much threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. Despite its noteworthy liabilities, Zeo Energy boasts net cash, so it's fair to say it does not have a heavy debt load!

It is just as well that Zeo Energy's load is not too heavy, because its EBIT was down 24% over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Zeo Energy's earnings that will influence how the balance sheet holds up in the future. 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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While Zeo Energy 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. Over the last three years, Zeo Energy actually produced more free cash flow than EBIT. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Summing Up

We could understand if investors are concerned about Zeo Energy's liabilities, but we can be reassured by the fact it has has net cash of US$6.23m. The cherry on top was that in converted 117% of that EBIT to free cash flow, bringing in US$10m. So we don't have any problem with Zeo Energy's use of debt. 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. Case in point: We've spotted 2 warning signs for Zeo Energy you should be aware of, and 1 of them is significant.

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. 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.