Renergen (JSE:REN) Is Making Moderate Use Of Debt

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. Importantly, Renergen Limited (JSE:REN) does carry debt. But should shareholders be worried about its use of debt?

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. 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 think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Renergen

What Is Renergen's Debt?

As you can see below, at the end of February 2024, Renergen had R1.24b of debt, up from R911.0m a year ago. Click the image for more detail. However, because it has a cash reserve of R473.6m, its net debt is less, at about R762.5m.

A Look At Renergen's Liabilities

According to the last reported balance sheet, Renergen had liabilities of R571.6m due within 12 months, and liabilities of R816.5m due beyond 12 months. Offsetting these obligations, it had cash of R473.6m as well as receivables valued at R21.7m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by R892.8m.

This deficit is considerable relative to its market capitalization of R1.32b, so it does suggest shareholders should keep an eye on Renergen's use of debt. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Renergen can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Over 12 months, Renergen reported revenue of R29m, which is a gain of 128%, although it did not report any earnings before interest and tax. So its pretty obvious shareholders are hoping for more growth!

Caveat Emptor

Despite the top line growth, Renergen still had an earnings before interest and tax (EBIT) loss over the last year. Indeed, it lost R120m at the EBIT level. Considering that alongside the liabilities mentioned above does not give us much confidence that company should be using so much debt. So we think its balance sheet is a little strained, though not beyond repair. Another cause for caution is that is bled R358m in negative free cash flow over the last twelve months. So in short it's a really risky stock. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should learn about the 6 warning signs we've spotted with Renergen (including 2 which can't be ignored) .

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com