Berkshire Hathaway’s Charlie Munger-backed external fund manager Li Lu is quick to say “The biggest risk in investing is not price volatility, but whether you will suffer a permanent loss of capital”. So it can be obvious that you need to consider debt, when you think about how risky a given stock is, because too much debt can sink a business. Like many other companies Focus on Energy, Inc. (NASDAQ: EFOI) uses debt. But the most important question is: what risk does this debt create?
When is debt dangerous?
Debt is a tool to help businesses grow, but if a business is unable to repay its lenders, then it exists at their mercy. Ultimately, if the company cannot meet its legal debt repayment obligations, shareholders could walk away with nothing. However, a more common (but still painful) scenario is that he must raise new equity at low cost, thereby diluting shareholders over the long term. Of course, the advantage of debt is that it often represents cheap capital, especially when it replaces dilution in a business with the ability to reinvest at high rates of return. When we think of a business’s use of debt, we first look at cash flow and debt together.
Discover our latest analysis for Energy Focus
How much debt does Energy Focus have?
As you can see below, at the end of March 2021, Energy Focus was in debt of $ 3.42 million, down from $ 1.64 million a year ago. Click on the image for more details. However, he also had $ 1.33 million in cash, so his net debt is $ 2.08 million.
How strong is Energy Focus’s balance sheet?
Zooming in on the latest balance sheet data, we can see that Energy Focus had a liability of US $ 8.88 million due within 12 months and US $ 172.0,000 liability beyond. In compensation for these obligations, it had cash of US $ 1.33 million as well as receivables valued at US $ 1.49 million within 12 months. Its liabilities therefore total US $ 6.23 million more than the combination of its cash and short-term receivables.
While this may sound like a lot, it’s not that big of a deal as Energy Focus has a market capitalization of US $ 18.7 million, and therefore could likely strengthen its balance sheet by raising capital if needed. But it is clear that it is absolutely necessary to take a close look at whether it can manage its debt without dilution. When analyzing debt levels, the balance sheet is the obvious starting point. But it is future profits, more than anything, that will determine Energy Focus’s ability to maintain a healthy balance sheet in the future. So if you are focused on the future you can check out this free report showing analysts’ earnings forecasts.
Year over 12 months, Energy Focus reported sales of US $ 16 million, an 18% gain, although it reported no profit before interest and taxes. We generally like to see unprofitable businesses growing faster, but each in their own way.
Over the past twelve months, Energy Focus has generated earnings before interest and taxes (EBIT). Indeed, it lost a very substantial US $ 5.2 million in EBIT. When we look at this and recall the liabilities on its balance sheet, versus the cash flow, it seems unwise to us that the company has debt. We therefore believe that its record is a bit strained, but not irreparable. However, it doesn’t help that he spent US $ 6.0 million in cash in the past year. Suffice it to say that we consider the title very risky. The balance sheet is clearly the area you need to focus on when analyzing debt. However, not all investment risks lie on the balance sheet – far from it. These risks can be difficult to spot. Every business has them, and we’ve spotted 5 warning signs for Energy Focus (2 of which are significant!) that you should know.
At the end of the day, it’s often best to focus on businesses that don’t have net debt. You can access our special list of these companies (all with a history of profit growth). It’s free.
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