Berkshire Hathaway’s Charlie Munger-backed outside fund manager Li Lu is quick to say, “The biggest risk in investing isn’t price volatility, but whether you’re going to suffer a permanent loss of capital “. So it may be obvious that you need to take debt into account when thinking about the risk of a given stock, because too much debt can sink a business. Above all, Crown Point Energy Inc. (CVE:CWV) is indebted. But the real question is whether this debt makes the business risky.
When is debt dangerous?
Generally speaking, debt only becomes a real problem when a company cannot easily repay it, either by raising capital or with its own cash flow. An integral part of capitalism is the process of “creative destruction” where bankrupt companies are mercilessly liquidated by their bankers. However, a more frequent (but still costly) event is when a company has to issue shares at bargain prices, permanently diluting shareholders, just to shore up its balance sheet. That said, the most common situation is when a company manages its debt reasonably well – and to its own benefit. The first thing to do when considering how much debt a business has is to look at its cash and debt together.
Check out our latest analysis for Crown Point Energy
What is Crown Point Energy’s debt?
The image below, which you can click on for more details, shows that in September 2021, Crown Point Energy had $5.45 million in debt, up from $1.67 million in one year. However, he also had $3.31 million in cash, so his net debt is $2.14 million.
How healthy is Crown Point Energy’s balance sheet?
The latest balance sheet data shows that Crown Point Energy had liabilities of US$4.57 million due within one year, and liabilities of US$20.0 million falling due thereafter. In compensation for these obligations, it had cash of US$3.31 million as well as receivables valued at US$1.85 million and maturing within 12 months. Thus, its liabilities outweigh the sum of its cash and receivables (current) by $19.4 million.
When you consider that shortfall exceeds the company’s US$14.0 million market capitalization, you may well be inclined to take a close look at the balance sheet. In theory, extremely large dilution would be required if the company were forced to repay its debts by raising capital at the current share price.
In order to assess a company’s debt relative to its earnings, we calculate its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and its earnings before interest and taxes (EBIT) divided by its expenses. interest (its interest coverage). The advantage of this approach is that we consider both the absolute amount of debt (with net debt to EBITDA) and the actual interest expense associated with that debt (with its interest coverage ratio ).
Crown Point Energy has a very low debt to EBITDA ratio of 0.13, so it’s odd to see low interest coverage, with last year’s EBIT being only 0.26 times interest expense . So, even if we are not necessarily alarmed, we think that his debt is far from trivial. Notably, Crown Point Energy posted a loss in EBIT last year, but improved to a positive EBIT of USD 190,000 in the last twelve months. When analyzing debt levels, the balance sheet is the obvious starting point. But you can’t look at debt in total isolation; since Crown Point Energy will need revenue to repay this debt. So, if you want to know more about its earnings, it may be worth checking out this graph of its long-term trend.
But our last consideration is also important, because a company cannot pay debt with paper profits; he needs cash. It is therefore worth checking how much of earnings before interest and tax (EBIT) is supported by free cash flow. Fortunately for all shareholders, Crown Point Energy has actually produced more free cash flow than EBIT over the past year. This kind of strong cash generation warms our hearts like a puppy in a bumblebee suit.
Our point of view
We feel some trepidation about Crown Point Energy’s trouble interest coverage, but we also have some positives to focus on. Namely, its conversion of EBIT to free cash flow and net debt to EBITDA were encouraging signs. When we consider all the factors discussed, it seems to us that Crown Point Energy is taking risks with its use of debt. So even if this leverage increases return on equity, we wouldn’t really want to see it increase from now on. There is no doubt that we learn the most about debt from the balance sheet. But at the end of the day, every business can contain risks that exist outside of the balance sheet. For example, we have identified 3 warning signs for Crown Point Energy (1 makes us a little uneasy) that you should be aware of.
Of course, if you’re the type of investor who prefers to buy stocks without the burden of debt, then feel free to check out our exclusive list of cash-efficient growth stocks today.
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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.
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