Legendary fund manager Li Lu (who Charlie Munger supported) once said, “The biggest risk in investing is not price volatility, but the possibility that you will suffer a permanent loss of capital. When we think about how risky a business is, we always like to look at its use of debt because debt overload can lead to bankruptcy. Like many other companies Limited company FAR-EASERN ENERGY COMPANY (MCX: DVEC) uses debt. But the real question is whether this debt makes the business risky.

When Is Debt a Problem?

Debt helps a business until the business struggles to repay it, either with new capital or with free cash flow. Ultimately, if the company cannot meet its legal debt repayment obligations, shareholders could walk away with nothing. While it’s not too common, we often see indebted companies continually diluting their shareholders because lenders are forcing them to raise capital at a ridiculous price. Of course, many companies use debt to finance their growth without negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash flow and debt together.

Check out our latest review for FAR EAST ENERGY

What is the net debt of FAR-EASERN ENERGY?

As you can see below, FAR-EASTERN ENERGY had 13.6 billion yen in debt in June 2021, up from 90.3 billion yen the previous year. However, given that it has a cash reserve of 5.56 billion yen, its net debt is less, at around 8.08 billion yen.

How healthy is FAR-EASTERN ENERGY’s balance sheet?

We can see from the most recent balance sheet that FAR-EASTERN ENERGY had liabilities of 22.5 billion yen due within one year and liabilities of 15.7 billion yen due beyond. In compensation for these obligations, he had cash of 5.56 billion euros as well as receivables valued at 8.58 billion euros within 12 months. Thus, its liabilities exceed the sum of its cash and (short-term) receivables by 24.1b.

The lack here weighs heavily on ₽15.5b society itself, as if a child struggles under the weight of a huge backpack full of books, his sports equipment, and a trumpet. So we would be watching its record closely, without a doubt. After all, FAR-EASTERN ENERGY would likely need a major recapitalization if it were to pay its creditors today.

We measure a company’s debt load relative to its earning capacity by looking at its net debt divided by its earnings before interest, taxes, depreciation, and amortization (EBITDA) and calculating how easily its earnings before interest and taxes (EBIT) covers its interest costs (interest coverage). Thus, we look at debt over earnings with and without amortization charges.

FAR-EASERN ENERGY has a low debt / EBITDA ratio of only 0.21. And remarkably, despite her net debt, she actually received more interest in the past twelve months than she had to pay. So it’s fair to say he can handle debt like a hotshot teppanyaki chef handles the kitchen. But the bad news is that FAR-EASTERN ENERGY has seen its EBIT drop 16% over the past twelve months. We believe that this type of performance, if repeated frequently, could well cause difficulties for the title. When analyzing debt levels, the balance sheet is the obvious starting point. But you can’t look at debt in isolation; since FAR-EASERN ENERGY will need revenue to service this debt. So, if you want to know more about its profits, it may be worth checking out this chart of its long term profit trend.

But our last consideration is also important, because a business cannot pay its debts with paper profits; he needs hard cash. We therefore always check how much of this EBIT is converted into free cash flow. Over the past three years, FAR-EASTERN ENERGY has recorded a significant negative free cash flow overall. While this may be the result of spending on growth, it makes debt much riskier.

Our point of view

At first glance, FAR-EASTERN ENERGY’s level of total liabilities left us hesitant about stock, and its conversion from EBIT to free cash flow was no more appealing than just empty restaurant on the busiest night. of the year. But at least it’s decent enough to cover its interest costs with its EBIT; it’s encouraging. It should also be noted that companies in the electric utility sector like FAR-EASTERN ENERGY generally use debt without a problem. We are pretty clear that we consider FAR-EASERN ENERGY to be really quite risky, because of the health of its balance sheet. For this reason, we are quite cautious on the stock, and we believe that shareholders should keep a close eye on its liquidity. 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 off the balance sheet. For example, FAR EAST ENERGY has 4 warning signs (and 3 that make us uncomfortable) we think you should know about.

Of course, if you are the type of investor who prefers to buy stocks without going into debt, feel free to check out our exclusive list of cash net 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 using only unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell shares and does not take into account your goals or your financial situation. Our aim is to bring you long-term, targeted analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price sensitive companies or qualitative material. Simply Wall St has no position in the mentioned stocks.
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