We believe that OPC Energy (TLV: OPCE) is taking risks with its debt
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. 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 OPC Énergie Ltée (TLV: OPCE) uses debt in its business. But the most important question is: what risk does this debt create?
When is debt dangerous?
Debt is a tool to help businesses grow, but if a business is unable to repay its lenders, then it exists at their mercy. If things really go wrong, lenders can take over the business. However, a more common (but still costly) situation is where a company has to dilute its shareholders at a cheap share price just to get its debt under control. That said, the most common situation is where a business manages its debt reasonably well – and to its own advantage. The first step in examining a company’s debt levels is to consider its cash flow and debt together.
Check out our latest review for OPC Energy
What is OPC Energy’s debt?
The image below, which you can click for more details, shows that in March 2021, OPC Energy had a debt of 3.51 billion yen, up from 2.35 billion yen in a year. On the other hand, it has 850.0 million yen in cash, resulting in net debt of around 2.66 billion yen.
How strong is OPC Energy’s balance sheet?
We can see from the most recent balance sheet that OPC Energy had liabilities of 758.0 million yen due within one year and liabilities of 3.86 billion yen beyond. On the other hand, it had cash of 850.0 M and 240.0 M of receivables due within one year. Thus, its liabilities exceed the sum of its cash and (short-term) receivables by 3.53.
This deficit is significant compared to its market capitalization of 5.77 billion euros, so he suggests shareholders keep an eye on the use of OPC Energy debt. If its lenders asked it to consolidate the balance sheet, shareholders would likely face serious dilution.
We use two main ratios to inform us about the levels of debt compared to earnings. The first is net debt divided by earnings before interest, taxes, depreciation, and amortization (EBITDA), while the second is the number of times its profit before interest and taxes (EBIT) covers its interest expense (or its coverage of interest, for short). In this way, we consider both the absolute amount of debt, as well as the interest rates paid on it.
OPC Energy shareholders are faced with the double whammy of a high net debt / EBITDA ratio (9.3) and relatively low interest coverage, since EBIT is only 1.9 times the interest charges. The debt burden here is considerable. Worse still, OPC Energy’s EBIT fell by 30% compared to last year. If profits continue to follow this path, it will be more difficult to pay off this debt than to convince us to run a marathon in the rain. When analyzing debt levels, the balance sheet is the obvious starting point. But it is OPC Energy’s earnings that will influence the balance sheet in the future. So, if you want to know more about its profits, it may be worth checking out this chart of its long term profit trend.
Finally, a business needs free cash flow to pay off debts; accounting profits are not enough. We therefore always check how much of this EBIT is converted into free cash flow. Over the past three years, OPC Energy has recorded free cash flow of 52% of its EBIT, which is close to normal given that free cash flow excludes interest and taxes. This free cash flow puts the business in a good position to repay debt, if any.
Our point of view
At first glance, OPC Energy’s net debt to EBITDA left us hesitant about the stock, and its EBIT growth rate was no more attractive than the single empty restaurant on the busiest night. of the year. But at least his conversion from EBIT to free cash isn’t that bad. Overall, it seems to us that OPC Energy’s balance sheet is really very risky for the company. We are therefore almost as wary of this stock as a hungry kitten falls into its owner’s fish pond: once bitten, twice shy, as they say. When analyzing debt levels, the balance sheet is the obvious starting point. However, not all investment risks lie on the balance sheet – far from it. For example, we have identified 3 warning signs for OPC Energy (2 are of concern) you should be aware of.
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 net growth stocks.
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