Etion (JSE:ETO) Seems To Use Debt Quite Sensibly

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says '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. We can see that Etion Limited (JSE:ETO) does use debt in its business. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for Etion

What Is Etion's Net Debt?

The image below, which you can click on for greater detail, shows that Etion had debt of R32.5m at the end of September 2021, a reduction from R60.2m over a year. But on the other hand it also has R162.9m in cash, leading to a R130.4m net cash position.

A Look At Etion's Liabilities

According to the last reported balance sheet, Etion had liabilities of R284.6m due within 12 months, and liabilities of R54.9m due beyond 12 months. Offsetting these obligations, it had cash of R162.9m as well as receivables valued at R189.2m due within 12 months. So it can boast R12.6m more liquid assets than total liabilities.

This surplus suggests that Etion has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Etion has more cash than debt is arguably a good indication that it can manage its debt safely.

It was also good to see that despite losing money on the EBIT line last year, Etion turned things around in the last 12 months, delivering and EBIT of R46m. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Etion'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 company can only pay off debt with cold hard cash, not accounting profits. Etion may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Happily for any shareholders, Etion actually produced more free cash flow than EBIT over the last year. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Etion has net cash of R130.4m, as well as more liquid assets than liabilities. The cherry on top was that in converted 392% of that EBIT to free cash flow, bringing in R182m. So we don't think Etion's use of debt is risky. 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. These risks can be hard to spot. Every company has them, and we've spotted 3 warning signs for Etion (of which 1 is a bit unpleasant!) you should know about.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.