Legendary fund manager Li Lu (who Charlie Munger backed) once said, ‘The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital. So it seems the smart money knows that debt – which is usually involved in bankruptcies – is a very important factor, when you assess how risky a company is. We note that Eidesvik Offshore ASA (OB:EIOF) does have debt on its balance sheet. 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. Part and parcel of capitalism is the process of ‘creative destruction’ where failed businesses are mercilessly liquidated by their bankers. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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 Eidesvik Offshore Carry?
The chart below, which you can click on for greater detail, shows that Eidesvik Offshore had kr2.45b in debt in December 2019; about the same as the year before. However, because it has a cash reserve of kr408.3m, its net debt is less, at about kr2.04b.
A Look At Eidesvik Offshore’s Liabilities
We can see from the most recent balance sheet that Eidesvik Offshore had liabilities of kr216.7m falling due within a year, and liabilities of kr2.41b due beyond that. Offsetting this, it had kr408.3m in cash and kr239.9m in receivables that were due within 12 months. So it has liabilities totalling kr1.98b more than its cash and near-term receivables, combined.
This deficit casts a shadow over the kr220.0m company, like a colossus towering over mere mortals. So we’d watch its balance sheet closely, without a doubt. After all, Eidesvik Offshore would likely require a major re-capitalisation if it had to pay its creditors today. There’s no doubt that we learn most about debt from the balance sheet. But it is Eidesvik Offshore’s earnings that will influence how the balance sheet holds up in the future. So when considering debt, it’s definitely worth looking at the earnings trend. Click here for an interactive snapshot.
Over 12 months, Eidesvik Offshore reported revenue of kr633m, which is a gain of 32%, although it did not report any earnings before interest and tax. With any luck the company will be able to grow its way to profitability.
Despite the top line growth, Eidesvik Offshore still had negative earnings before interest and tax (EBIT), over the last year. Indeed, it lost a very considerable kr34m at the EBIT level. When you combine this with the very significant balance sheet liabilities mentioned above, we are so wary of it that we are basically at a loss for the right words. Sure, the company might have a nice story about how they are going on to a brighter future. But the reality is that it is low on liquid assets relative to liabilities, and it lost kr120m in the last year. So we think buying this stock is risky, like walking through a minefield with a mask on. There’s no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet – far from it. Consider for instance, the ever-present spectre of investment risk. We’ve identified 4 warning signs with Eidesvik Offshore , and understanding them should be part of your investment process.
At the end of the day, it’s often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It’s free.
If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned.
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