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Otto Energy (ASX:OEL) Could Easily Take On More Debt

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Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We note that Otto Energy Limited (ASX:OEL) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Otto Energy

How Much Debt Does Otto Energy Carry?

As you can see below, Otto Energy had US$6.05m of debt at December 2021, down from US$14.2m a year prior. But on the other hand it also has US$24.2m in cash, leading to a US$18.2m net cash position.

debt-equity-history-analysis
debt-equity-history-analysis

How Strong Is Otto Energy's Balance Sheet?

The latest balance sheet data shows that Otto Energy had liabilities of US$12.5m due within a year, and liabilities of US$5.13m falling due after that. Offsetting this, it had US$24.2m in cash and US$3.51m in receivables that were due within 12 months. So it actually has US$10.1m more liquid assets than total liabilities.

This excess liquidity suggests that Otto Energy is taking a careful approach to debt. Given it has easily adequate short term liquidity, we don't think it will have any issues with its lenders. Succinctly put, Otto Energy boasts net cash, so it's fair to say it does not have a heavy debt load!

It was also good to see that despite losing money on the EBIT line last year, Otto Energy turned things around in the last 12 months, delivering and EBIT of US$19m. There's no doubt that we learn most about debt from the balance sheet. But it is Otto Energy's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Otto Energy may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. During the last year, Otto Energy generated free cash flow amounting to a very robust 81% of its EBIT, more than we'd expect. That positions it well to pay down debt if desirable to do so.

Summing up

While it is always sensible to investigate a company's debt, in this case Otto Energy has US$18.2m in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of US$16m, being 81% of its EBIT. So is Otto Energy's debt a risk? It doesn't seem so to us. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. To that end, you should be aware of the 3 warning signs we've spotted with Otto Energy .

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.

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