We Think Australis Oil & Gas (ASX:ATS) Can Stay On Top Of Its Debt

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that '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 Australis Oil & Gas Limited (ASX:ATS) does use debt in its business. But is this debt a concern to shareholders?

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. 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, 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 Australis Oil & Gas

How Much Debt Does Australis Oil & Gas Carry?

As you can see below, Australis Oil & Gas had US$11.9m of debt at December 2022, down from US$16.7m a year prior. However, it also had US$7.85m in cash, and so its net debt is US$4.02m.

A Look At Australis Oil & Gas' Liabilities

Zooming in on the latest balance sheet data, we can see that Australis Oil & Gas had liabilities of US$13.4m due within 12 months and liabilities of US$10.9m due beyond that. On the other hand, it had cash of US$7.85m and US$3.14m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$13.4m.

This deficit isn't so bad because Australis Oil & Gas is worth US$25.0m, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Australis Oil & Gas has a very low debt to EBITDA ratio of 0.74 so it is strange to see weak interest coverage, with last year's EBIT being only 2.3 times the interest expense. So while we're not necessarily alarmed we think that its debt is far from trivial. Notably, Australis Oil & Gas made a loss at the EBIT level, last year, but improved that to positive EBIT of US$2.6m in the last twelve months. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Australis Oil & Gas's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So it's worth checking how much of the earnings before interest and tax (EBIT) is backed by free cash flow. Over the last year, Australis Oil & Gas actually produced more free cash flow than EBIT. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Our View

When it comes to the balance sheet, the standout positive for Australis Oil & Gas was the fact that it seems able to convert EBIT to free cash flow confidently. But the other factors we noted above weren't so encouraging. In particular, interest cover gives us cold feet. Considering this range of data points, we think Australis Oil & Gas is in a good position to manage its debt levels. But a word of caution: we think debt levels are high enough to justify ongoing monitoring. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 4 warning signs for Australis Oil & Gas you should be aware of, and 1 of them doesn't sit too well with us.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.