Legendary fund manager Li Lu (whom Charlie Munger once backed) once said, “The greatest risk in investing is not price volatility, but whether you will suffer a permanent loss of capital. When we think of a company’s risk, we always like to look at its use of debt, because over-indebtedness can lead to ruin. We note that swan limited energy (NSE:SWANENERGY) has debt on its balance sheet. But should shareholders worry about its use of debt?
When is debt dangerous?
Debt is a tool to help businesses grow, but if a business is unable to repay its lenders, it exists at their mercy. An integral part of capitalism is the process of “creative destruction” where bankrupt companies are mercilessly liquidated by their bankers. However, a more common (but still painful) scenario is that it has to raise new equity at a low price, thereby permanently diluting shareholders. That said, the most common situation is when a company manages its debt reasonably well – and to its own benefit. When we think about a company’s use of debt, we first look at cash and debt together.
See our latest analysis for Swan Energy
How much debt does Swan Energy have?
As you can see below, at the end of March 2022, Swan Energy had a debt of ₹41.0 billion, up from ₹30.8 billion a year ago. Click on the image for more details. On the other hand, he has ₹9.57 billion in cash, resulting in a net debt of around ₹31.4 billion.
How healthy is Swan Energy’s balance sheet?
We can see from the most recent balance sheet that Swan Energy had liabilities of ₹11.3 billion due within a year, and liabilities of ₹35.7 billion due beyond. As compensation for these obligations, it had cash of ₹9.57 billion as well as receivables valued at ₹3.05 billion due within 12 months. Thus, its liabilities total ₹34.4 billion more than the combination of its cash and short-term receivables.
This shortfall is not that bad as Swan Energy is worth ₹70.9 billion and therefore could probably raise enough capital to shore up its balance sheet, should the need arise. But we definitely want to keep our eyes peeled for indications that its debt is too risky. When analyzing debt levels, the balance sheet is the obvious starting point. But you can’t look at debt in total isolation; since Swan Energy will need revenue to repay this debt. So, when considering debt, it is definitely worth looking at the earnings trend. Click here for an interactive preview.
Over 12 months, Swan Energy reported revenue of ₹4.9 billion, a gain of 52%, despite reporting no earnings before interest and tax. With a little luck, the company will be able to progress towards profitability.
Even though Swan Energy has managed to grow its top line quite ably, the harsh truth is that it is losing money on the EBIT line. Indeed, it lost ₹20 million in EBIT. Considering that alongside the liabilities mentioned above, this doesn’t give us much confidence that the company should use so much debt. So we think its balance sheet is a little stretched, but not beyond repair. However, it doesn’t help that he burned through ₹4.6 billion in cash in the last year. So suffice it to say that we consider the stock to be very risky. 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, Swan Energy has 4 warning signs (and 2 that make us uncomfortable) that we think you should know about.
If you are interested in investing in companies that can generate profits without the burden of debt, then check out this free list of growing companies that have net cash on the balance sheet.
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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.