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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.' 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 Energy One Limited (ASX:EOL) makes use of debt. But the more important question is: how much risk is that debt creating?
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. 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 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 Energy One
How Much Debt Does Energy One Carry?
As you can see below, at the end of June 2019, Energy One had AU$6.49m of debt, up from AU$121 a year ago. Click the image for more detail. On the flip side, it has AU$2.22m in cash leading to net debt of about AU$4.27m.
A Look At Energy One's Liabilities
According to the last reported balance sheet, Energy One had liabilities of AU$8.14m due within 12 months, and liabilities of AU$6.85m due beyond 12 months. On the other hand, it had cash of AU$2.22m and AU$4.60m worth of receivables due within a year. So it has liabilities totalling AU$8.17m more than its cash and near-term receivables, combined.
This deficit isn't so bad because Energy One is worth AU$39.6m, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt.
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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.