We Think Beach Energy (ASX:BPT) 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.' 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. Importantly, Beach Energy Limited (ASX:BPT) does carry debt. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

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. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Beach Energy

What Is Beach Energy's Net Debt?

The image below, which you can click on for greater detail, shows that Beach Energy had debt of AU$136.8m at the end of December 2021, a reduction from AU$158.0m over a year. But it also has AU$213.2m in cash to offset that, meaning it has AU$76.4m net cash.

A Look At Beach Energy's Liabilities

According to the last reported balance sheet, Beach Energy had liabilities of AU$425.9m due within 12 months, and liabilities of AU$1.19b due beyond 12 months. On the other hand, it had cash of AU$213.2m and AU$224.7m worth of receivables due within a year. So its liabilities total AU$1.17b more than the combination of its cash and short-term receivables.

While this might seem like a lot, it is not so bad since Beach Energy has a market capitalization of AU$4.03b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But it's clear that we should definitely closely examine whether it can manage its debt without dilution. Despite its noteworthy liabilities, Beach Energy boasts net cash, so it's fair to say it does not have a heavy debt load!

Also positive, Beach Energy grew its EBIT by 23% in the last year, and that should make it easier to pay down debt, going forward. 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're focused on the future you can check out this free report showing analyst profit forecasts.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. 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. Looking at the most recent three years, Beach Energy recorded free cash flow of 27% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying 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$76.4m. And we liked the look of last year's 23% year-on-year EBIT growth. So we don't have any problem with Beach Energy's use of debt. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. We've identified 1 warning sign with Beach Energy , 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.

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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.