Etion (JSE:ETO) Has Debt But No Earnings; Should You Worry?

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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. As with many other companies Etion Limited (JSE:ETO) makes use of debt. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. 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, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Etion

What Is Etion's Net Debt?

You can click the graphic below for the historical numbers, but it shows that Etion had R60.2m of debt in September 2020, down from R72.6m, one year before. But on the other hand it also has R60.4m in cash, leading to a R172.0k net cash position.

How Strong Is Etion's Balance Sheet?

The latest balance sheet data shows that Etion had liabilities of R110.3m due within a year, and liabilities of R84.7m falling due after that. Offsetting this, it had R60.4m in cash and R130.5m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by R4.09m.

Given Etion has a market capitalization of R163.7m, it's hard to believe these liabilities pose much threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. While it does have liabilities worth noting, Etion also has more cash than debt, so we're pretty confident it can manage its debt safely. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Etion 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.

Over 12 months, Etion made a loss at the EBIT level, and saw its revenue drop to R512m, which is a fall of 19%. That's not what we would hope to see.

So How Risky Is Etion?

We have no doubt that loss making companies are, in general, riskier than profitable ones. And we do note that Etion had an earnings before interest and tax (EBIT) loss, over the last year. And over the same period it saw negative free cash outflow of R3.6m and booked a R37m accounting loss. Given it only has net cash of R172.0k, the company may need to raise more capital if it doesn't reach break-even soon. 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. Take risks, for example - Etion has 3 warning signs (and 1 which is a bit concerning) we think you should know about.

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.

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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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