Spark Energy (NASDAQ:SPKE) Could Easily Take On More Debt

Warren Buffett famously said, '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. Importantly, Spark Energy, Inc. (NASDAQ:SPKE) does carry debt. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for Spark Energy

What Is Spark Energy's Net Debt?

The image below, which you can click on for greater detail, shows that Spark Energy had debt of US$99.6m at the end of September 2020, a reduction from US$119.5m over a year. However, it also had US$81.0m in cash, and so its net debt is US$18.6m.

How Healthy Is Spark Energy's Balance Sheet?

The latest balance sheet data shows that Spark Energy had liabilities of US$83.3m due within a year, and liabilities of US$100.5m falling due after that. On the other hand, it had cash of US$81.0m and US$68.4m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$34.4m.

Since publicly traded Spark Energy shares are worth a total of US$395.0m, it seems unlikely that this level of liabilities would be a major threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Spark Energy's net debt is only 0.21 times its EBITDA. And its EBIT covers its interest expense a whopping 10.5 times over. So you could argue it is no more threatened by its debt than an elephant is by a mouse. Better yet, Spark Energy grew its EBIT by 656% last year, which is an impressive improvement. If maintained that growth will make the debt even more manageable in the years ahead. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Spark Energy will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Over the last three years, Spark Energy actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Our View

Spark Energy's conversion of EBIT to free cash flow suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. And that's just the beginning of the good news since its EBIT growth rate is also very heartening. It's also worth noting that Spark Energy is in the Electric Utilities industry, which is often considered to be quite defensive. We think Spark Energy is no more beholden to its lenders, than the birds are to birdwatchers. For investing nerds like us its balance sheet is almost charming. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. For example Spark Energy has 4 warning signs (and 1 which doesn't sit too well with us) we think you should know about.

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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