Does Zodiac Energy (NSE: ZODIAC) have a healthy balance sheet?
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. We can see that Zodiac Energy Limited (NSE: ZODIAC) uses debt in its activity. But does this debt concern shareholders?
What risk does debt entail?
Debt is a tool to help businesses grow, but if a business is unable to repay its lenders, then it exists at their mercy. An integral part of capitalism is the process of “creative destruction” where bankrupt companies are ruthlessly liquidated by their bankers. However, a more common (but still costly) event is when a company has to issue stock at bargain prices, constantly diluting shareholders, just to strengthen its balance sheet. By replacing dilution, however, debt can be a very good tool for companies that need capital to invest in growth at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash flow and debt together.
Discover our latest analysis for Zodiac Energy
What is Zodiac Energy’s net debt?
You can click on the graph below for historical figures, but it shows that in March 2021, Zodiac Energy had â¬ 113.6 million in debt, an increase from â¬ 58.0 million, over a year. However, he also had 2.74 million yen in cash, so his net debt is 110.8 million yen.
How strong is Zodiac Energy’s balance sheet?
Zooming in on the latest balance sheet data, we can see that Zodiac Energy had a liability of 260.0 million yen due within 12 months and a liability of 14.6 million yen beyond. On the other hand, it had cash of 2.74 million and 322.8 million in receivables due within one year. So he can boast of 51.0 million yen more total Liabilities.
This excess liquidity suggests that Zodiac Energy is taking a cautious approach to debt. Because he has a lot of assets, he is unlikely to have any problems with his lenders.
We measure a company’s indebtedness relative to its earning power by looking at its net debt divided by its earnings before interest, taxes, depreciation, and amortization (EBITDA) and calculating the ease with which its earnings before interest and taxes (EBIT ) covers its interests. costs (interest coverage). Thus, we consider debt versus earnings with and without amortization charges.
Zodiac Energy’s net debt of 1.5 times EBITDA suggests a graceful use of debt. And the attractive interest coverage (EBIT of 7.5 times the interest costs) certainly does do not do everything to dispel this impression. On top of that, we are happy to report that Zodiac Energy has increased its EBIT by 41%, reducing the specter of future debt repayments. The balance sheet is clearly the area you need to focus on when analyzing debt. But it is the results of Zodiac Energy that will influence the performance of the balance sheet in the future. So if you want to know more about its profits, it might be worth checking out this long term profit trend chart.
But our last consideration is also important, because a company cannot pay its debts with paper profits; he needs hard cash. The logical step is therefore to examine the proportion of this EBIT that corresponds to the actual free cash flow. Over the past three years, Zodiac Energy has spent a lot of money. While this may be the result of spending on growth, it makes debt much riskier.
Our point of view
The good news is that Zodiac Energy’s demonstrated ability to increase EBIT thrills us like a fluffy puppy does a toddler. But the hard truth is that we are concerned about its conversion from EBIT to free cash flow. All these things considered, it looks like Zodiac Energy can comfortably manage its current level of debt. On the plus side, this leverage can increase returns for shareholders, but the potential downside is more risk of loss, so it’s worth watching the balance sheet. The balance sheet is clearly the area 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 3 warning signs for Zodiac Energy you should know.
If, after all of this, you’re more interested in a fast-growing company with a strong balance sheet, take a quick look at our list of cash-flow net-growth stocks.
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