We Think Orbital (ASX:OEC) Has A Fair Chunk Of Debt

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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 note that Orbital Corporation Limited (ASX:OEC) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

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. If things get really bad, the lenders can take control of the business. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Orbital

What Is Orbital's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of June 2021 Orbital had AU$9.99m of debt, an increase on AU$8.61m, over one year. However, it does have AU$3.12m in cash offsetting this, leading to net debt of about AU$6.87m.

A Look At Orbital's Liabilities

According to the last reported balance sheet, Orbital had liabilities of AU$21.5m due within 12 months, and liabilities of AU$919.0k due beyond 12 months. Offsetting these obligations, it had cash of AU$3.12m as well as receivables valued at AU$4.34m due within 12 months. So its liabilities total AU$15.0m more than the combination of its cash and short-term receivables.

While this might seem like a lot, it is not so bad since Orbital has a market capitalization of AU$35.0m, and so it could probably strengthen its balance sheet by raising capital if it needed to. However, it is still worthwhile taking a close look at its ability to pay off debt. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Orbital can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Over 12 months, Orbital made a loss at the EBIT level, and saw its revenue drop to AU$31m, which is a fall of 7.6%. We would much prefer see growth.

Caveat Emptor

Importantly, Orbital had an earnings before interest and tax (EBIT) loss over the last year. Indeed, it lost a very considerable AU$4.2m at the EBIT level. When we look at that and recall the liabilities on its balance sheet, relative to cash, it seems unwise to us for the company to have any debt. So we think its balance sheet is a little strained, though not beyond repair. Another cause for caution is that is bled AU$3.8m in negative free cash flow over the last twelve months. So suffice it to say we consider the stock very risky. 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. For example Orbital has 4 warning signs (and 1 which makes us a bit uncomfortable) we think you should know about.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.