Does Canadian Natural Resources (TSE:CNQ) Have A Healthy Balance Sheet?

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 Canadian Natural Resources Limited (TSE:CNQ) does use debt in its business. But the real question is whether this debt is making the company risky.

AI is about to change healthcare. These 20 stocks are working on everything from early diagnostics to drug discovery. The best part - they are all under $10bn in marketcap - there is still time to get in early.

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

What Is Canadian Natural Resources's Net Debt?

As you can see below, at the end of December 2024, Canadian Natural Resources had CA$18.8b of debt, up from CA$10.8b a year ago. Click the image for more detail. Net debt is about the same, since the it doesn't have much cash.

How Healthy Is Canadian Natural Resources' Balance Sheet?

We can see from the most recent balance sheet that Canadian Natural Resources had liabilities of CA$9.63b falling due within a year, and liabilities of CA$36.3b due beyond that. On the other hand, it had cash of CA$144.0m and CA$4.13b worth of receivables due within a year. So its liabilities total CA$41.6b more than the combination of its cash and short-term receivables.

Canadian Natural Resources has a very large market capitalization of CA$83.2b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution.

View our latest analysis for Canadian Natural Resources

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). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Canadian Natural Resources has a low net debt to EBITDA ratio of only 1.1. And its EBIT covers its interest expense a whopping 16.4 times over. So you could argue it is no more threatened by its debt than an elephant is by a mouse. But the other side of the story is that Canadian Natural Resources saw its EBIT decline by 6.9% over the last year. That sort of decline, if sustained, will obviously make debt harder to handle. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Canadian Natural Resources 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. So it's worth checking how much of that EBIT is backed by free cash flow. Over the last three years, Canadian Natural Resources recorded free cash flow worth a fulsome 85% of its EBIT, which is stronger than we'd usually expect. That positions it well to pay down debt if desirable to do so.

Our View

Happily, Canadian Natural Resources's impressive interest cover implies it has the upper hand on its debt. But truth be told we feel its EBIT growth rate does undermine this impression a bit. Looking at all the aforementioned factors together, it strikes us that Canadian Natural Resources can handle its debt fairly comfortably. Of course, while this leverage can enhance returns on equity, it does bring more risk, so it's worth keeping an eye on this one. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 1 warning sign for Canadian Natural Resources you should be aware of.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.