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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.’ 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 Athabasca Oil Corporation (TSE:ATH) does use debt in its business. 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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, 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.
How Much Debt Does Athabasca Oil Carry?
The image below, which you can click on for greater detail, shows that at March 2019 Athabasca Oil had debt of CA$570.4m, up from CA$541.5m in one year. However, because it has a cash reserve of CA$272.2m, its net debt is less, at about CA$298.2m.
How Strong Is Athabasca Oil’s Balance Sheet?
According to the last reported balance sheet, Athabasca Oil had liabilities of CA$185.7m due within 12 months, and liabilities of CA$708.2m due beyond 12 months. On the other hand, it had cash of CA$272.2m and CA$168.6m worth of receivables due within a year. So it has liabilities totalling CA$453.0m more than its cash and near-term receivables, combined.
When you consider that this deficiency exceeds the company’s CA$371.0m market capitalization, you might well be inclined to review the balance sheet, just like one might study a new partner’s social media. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price. Since Athabasca Oil does have net debt, we think it is worthwhile for shareholders to keep an eye on the balance sheet, over time. There’s no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Athabasca Oil’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.
In the last year Athabasca Oil actually shrunk its revenue by 2.1%, to CA$808m. We would much prefer see growth.
Over the last twelve months Athabasca Oil produced an earnings before interest and tax (EBIT) loss. Indeed, it lost a very considerable CA$388m at the EBIT level. Considering that alongside the liabilities mentioned above make us nervous about the company. It would need to improve its operations quickly for us to be interested in it. Not least because it burned through CA$179m in negative free cash flow over the last year. That means it’s on the risky side of things. For riskier companies like Athabasca Oil I always like to keep an eye on whether insiders are buying or selling. So click here if you want to find out for yourself.
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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If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.