We Think Athabasca Oil (TSE:ATH) Can Stay On Top Of Its Debt

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. As with many other companies Athabasca Oil Corporation (TSE:ATH) makes use of debt. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. 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, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Athabasca Oil

How Much Debt Does Athabasca Oil Carry?

As you can see below, Athabasca Oil had CA$355.3m of debt at March 2022, down from CA$555.2m a year prior. However, it also had CA$213.5m in cash, and so its net debt is CA$141.8m.

How Healthy Is Athabasca Oil's Balance Sheet?

According to the last reported balance sheet, Athabasca Oil had liabilities of CA$502.7m due within 12 months, and liabilities of CA$402.1m due beyond 12 months. Offsetting this, it had CA$213.5m in cash and CA$158.7m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CA$532.5m.

Athabasca Oil has a market capitalization of CA$1.41b, so it could very likely raise cash to ameliorate 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.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Given net debt is only 0.74 times EBITDA, it is initially surprising to see that Athabasca Oil's EBIT has low interest coverage of 0.88 times. So while we're not necessarily alarmed we think that its debt is far from trivial. We also note that Athabasca Oil improved its EBIT from a last year's loss to a positive CA$79m. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Athabasca Oil will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it is important to check how much of its earnings before interest and tax (EBIT) converts to actual free cash flow. Over the last year, Athabasca Oil actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Our View

Athabasca Oil's interest cover was a real negative on this analysis, although the other factors we considered were considerably better. There's no doubt that its ability to to convert EBIT to free cash flow is pretty flash. When we consider all the elements mentioned above, it seems to us that Athabasca Oil is managing its debt quite well. But a word of caution: we think debt levels are high enough to justify ongoing monitoring. 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. For example, we've discovered 3 warning signs for Athabasca Oil that you should be aware of before investing here.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.