Warren Buffett famously said, ‘Volatility is far from synonymous with risk.’ When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We can see that Eneti Inc. (NYSE:NETI) does use debt in its business. But the real question is whether this debt is making the company risky.
When Is Debt A Problem?
Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Ultimately, if the company can’t fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Having said that, the most common situation is where a company manages its debt reasonably well – and to its own advantage. The first step when considering a company’s debt levels is to consider its cash and debt together.
How Much Debt Does Eneti Carry?
You can click the graphic below for the historical numbers, but it shows that Eneti had US$72.5m of debt in March 2021, down from US$389.6m, one year before. However, its balance sheet shows it holds US$81.5m in cash, so it actually has US$8.97m net cash.
How Strong Is Eneti’s Balance Sheet?
We can see from the most recent balance sheet that Eneti had liabilities of US$51.5m falling due within a year, and liabilities of US$234.0m due beyond that. Offsetting this, it had US$81.5m in cash and US$23.7m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$180.2m.
Given this deficit is actually higher than the company’s market capitalization of US$172.5m, we think shareholders really should watch Eneti’s debt levels, like a parent watching their child ride a bike for the first time. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price. Eneti boasts net cash, so it’s fair to say it does not have a heavy debt load, even if it does have very significant liabilities, in total. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Eneti can strengthen its balance sheet over time.
Over 12 months, Eneti made a loss at the EBIT level, and saw its revenue drop to US$183m, which is a fall of 15%. That’s not what we would hope to see.
So How Risky Is Eneti?
Statistically speaking companies that lose money are riskier than those that make money. And the fact is that over the last twelve months Eneti lost money at the earnings before interest and tax (EBIT) line. And over the same period it saw negative free cash outflow of US$38m and booked a US$505m accounting loss. However, it has net cash of US$8.97m, so it has a bit of time before it will need more capital. Overall, we’d say the stock is a bit risky, and we’re usually very cautious until we see positive free cash flow. The balance sheet is clearly the area to focus on when you are analysing debt.