Is Beach Energy (ASX:BPT) Using Too Much Debt?

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 might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. As with many other companies Beach Energy Limited (ASX:BPT) makes use of debt. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for Beach Energy

What Is Beach Energy's Debt?

As you can see below, Beach Energy had AU$87.3m of debt at June 2022, down from AU$174.1m a year prior. However, its balance sheet shows it holds AU$254.5m in cash, so it actually has AU$167.2m net cash.

How Healthy Is Beach Energy's Balance Sheet?

We can see from the most recent balance sheet that Beach Energy had liabilities of AU$491.6m falling due within a year, and liabilities of AU$1.07b due beyond that. On the other hand, it had cash of AU$254.5m and AU$238.1m worth of receivables due within a year. So its liabilities total AU$1.07b more than the combination of its cash and short-term receivables.

This deficit isn't so bad because Beach Energy is worth AU$3.66b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. While it does have liabilities worth noting, Beach Energy also has more cash than debt, so we're pretty confident it can manage its debt safely.

In addition to that, we're happy to report that Beach Energy has boosted its EBIT by 74%, thus reducing the spectre of future debt repayments. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Beach Energy's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. While Beach Energy has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. In the last three years, Beach Energy created free cash flow amounting to 20% of its EBIT, an uninspiring performance. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.

Summing Up

While Beach Energy does have more liabilities than liquid assets, it also has net cash of AU$167.2m. And we liked the look of last year's 74% year-on-year EBIT growth. So we don't have any problem with Beach Energy's use of debt. Of course, we wouldn't say no to the extra confidence that we'd gain if we knew that Beach Energy insiders have been buying shares: if you're on the same wavelength, you can find out if insiders are buying by clicking this link.

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.