David Iben put it right when he said: “Volatility is not a risk that is close to our hearts. What matters to us is to avoid the permanent loss of capital. So it might be obvious, then, that you need to factor in debt, when you think about how risky a given stock is because too much debt can sink a business. We notice that Photon Energy NV (WSE: PEN) has debt on its balance sheet. But should shareholders be worried about its use of debt?

What risk does debt entail?

Debt helps a business until it struggles to pay it off, either with new capital or with free cash flow. 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) situation is where a company has to issue shares at bargain prices, constantly diluting shareholders, just to strengthen its balance sheet. Of course, many companies use debt to finance growth without any negative consequences. When we look at debt levels, we first look at cash and debt levels, together.

Check out our latest analysis for Photon Energy

What is Photon Energy’s debt?

As you can see below, at the end of December 2020, Photon Energy had € 97.7m in debt, up from € 80.4m a year ago. Click on the image for more details. However, he also had € 9.89m in cash, so his net debt is € 87.8m.

How strong is Photon Energy’s balance sheet?

The latest balance sheet data shows that Photon Energy had liabilities of € 15.2 million within one year and liabilities of € 103.6 million due thereafter. In return, he had € 9.89 million in cash and € 7.17 million in receivables due within 12 months. It therefore has liabilities of € 101.8 million more than its cash and short-term receivables combined.

This deficit is significant compared to its market capitalization of € 134.9m, so he suggests shareholders keep an eye on Photon Energy’s use of debt. If its lenders asked it to consolidate the balance sheet, shareholders would likely face severe dilution. There is no doubt that we learn the most about debt from the balance sheet. But you cannot view the debt in total isolation; since Photon Energy will need revenue to service this debt. So if you want to know more about his earnings, it might be worth checking out this chart of his long term profit trend.

Over 12 months, Photon Energy recorded a loss in EBIT and saw its turnover fall to € 28 million, a decrease of 6.3%. We would much prefer to see the growth.

Caveat Emptor

Importantly, Photon Energy has recorded a loss of earnings before interest and taxes (EBIT) over the past year. Indeed, it lost 479 K € in terms of EBIT. When we look at this and recall the liabilities of its balance sheet, versus the cash flow, it seems unwise to us that the company is in debt. We therefore believe that its record is a bit strained, but not irreparable. However, the fact that he has burned 13 million euros of cash in the last year does not help. So in short, it’s a really risky title. There is no doubt that we learn the most about debt from the balance sheet. However, not all investment risks lie on the balance sheet – far from it. Be aware that Photon Energy shows 4 warning signs in our investment analysis , and 2 of them are not very good with us …

At the end of the day, it’s often best to focus on businesses with no 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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