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.' 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 New Fortress Energy Inc. (NASDAQ:NFE) makes use of debt. But is this debt a concern to shareholders?
Why Does Debt Bring Risk?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. 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. The first step when considering a company's debt levels is to consider its cash and debt together.
How Much Debt Does New Fortress Energy Carry?
The image below, which you can click on for greater detail, shows that at March 2022 New Fortress Energy had debt of US$3.94b, up from US$1.24b in one year. However, it also had US$156.2m in cash, and so its net debt is US$3.79b.
How Strong Is New Fortress Energy's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that New Fortress Energy had liabilities of US$578.3m due within 12 months and liabilities of US$4.47b due beyond that. On the other hand, it had cash of US$156.2m and US$255.9m worth of receivables due within a year. So its liabilities total US$4.64b more than the combination of its cash and short-term receivables.
While this might seem like a lot, it is not so bad since New Fortress Energy has a market capitalization of US$9.33b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.
We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.
New Fortress Energy has a rather high debt to EBITDA ratio of 6.4 which suggests a meaningful debt load. However, its interest coverage of 3.1 is reasonably strong, which is a good sign. One redeeming factor for New Fortress Energy is that it turned last year's EBIT loss into a gain of US$463m, over the last twelve months. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine New Fortress Energy's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.
Finally, a company can only pay off debt with cold hard cash, not accounting profits. So it's worth checking how much of the earnings before interest and tax (EBIT) is backed by free cash flow. During the last year, New Fortress Energy burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.
To be frank both New Fortress Energy's net debt to EBITDA and its track record of converting EBIT to free cash flow make us rather uncomfortable with its debt levels. Having said that, its ability to grow its EBIT isn't such a worry. Overall, it seems to us that New Fortress Energy's balance sheet is really quite a risk to the business. So we're almost as wary of this stock as a hungry kitten is about falling into its owner's fish pond: once bitten, twice shy, as they say. 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 example, we've discovered 4 warning signs for New Fortress Energy (3 are a bit unpleasant!) that you should be aware of before investing here.
Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.
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.