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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We can see that Beach Energy Limited (ASX:BPT) does use debt in its business. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. If things get really bad, the lenders can take control of the business. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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.

Check out our latest analysis for Beach Energy

What Is Beach Energy's Debt?

You can click the graphic below for the historical numbers, but it shows that as of December 2022 Beach Energy had AU$177.8m of debt, an increase on AU$136.8m, over one year. But on the other hand it also has AU$189.5m in cash, leading to a AU$11.7m net cash position.

A Look At Beach Energy's Liabilities

We can see from the most recent balance sheet that Beach Energy had liabilities of AU$489.5m falling due within a year, and liabilities of AU$1.20b due beyond that. Offsetting this, it had AU$189.5m in cash and AU$265.3m in receivables that were due within 12 months. So it has liabilities totalling AU$1.23b more than its cash and near-term receivables, combined.

This deficit isn't so bad because Beach Energy is worth AU$2.99b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt. 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 30%, thus reducing the spectre of future debt repayments. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Beach Energy 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.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. Beach Energy may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Over the last three years, Beach Energy reported free cash flow worth 19% of its EBIT, which is really quite low. That limp level of cash conversion undermines its ability to manage and pay down debt.

Summing Up

Although Beach Energy's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of AU$11.7m. And it impressed us with its EBIT growth of 30% over the last year. So we are not troubled with Beach Energy's debt use. 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. For example - Beach Energy has 1 warning sign we think you should be aware of.

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.