Here's Why Athabasca Oil (TSE:ATH) Can Manage Its Debt Responsibly

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' 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 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?

Debt assists a business until the business has trouble paying it off, either with new capital or with free 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Athabasca Oil

What Is Athabasca Oil's Debt?

As you can see below, Athabasca Oil had CA$182.4m of debt at September 2023, down from CA$240.1m a year prior. However, its balance sheet shows it holds CA$337.1m in cash, so it actually has CA$154.7m net cash.

How Strong Is Athabasca Oil's Balance Sheet?

The latest balance sheet data shows that Athabasca Oil had liabilities of CA$240.6m due within a year, and liabilities of CA$281.4m falling due after that. On the other hand, it had cash of CA$337.1m and CA$130.9m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by CA$54.0m.

Of course, Athabasca Oil has a market capitalization of CA$2.54b, so these liabilities are probably manageable. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. Despite its noteworthy liabilities, Athabasca Oil boasts net cash, so it's fair to say it does not have a heavy debt load!

Shareholders should be aware that Athabasca Oil's EBIT was down 48% last year. If that earnings trend continues then paying off its debt will be about as easy as herding cats on to a roller coaster. 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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While Athabasca Oil 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. During the last three years, Athabasca Oil generated free cash flow amounting to a very robust 98% of its EBIT, more than we'd expect. That positions it well to pay down debt if desirable to do so.

Summing Up

While it is always sensible to look at a company's total liabilities, it is very reassuring that Athabasca Oil has CA$154.7m in net cash. And it impressed us with free cash flow of CA$158m, being 98% of its EBIT. So we are not troubled with Athabasca Oil's debt use. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. We've identified 1 warning sign with Athabasca Oil , and understanding them should be part of your investment process.

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.