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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.’ 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. As with many other companies. Cenovus Energy Inc. (TSE:CVE) makes use of debt. But the real question is whether this debt is making the company risky.
What Risk Does Debt Bring?
Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. If things get really bad, the lenders can take control of the business. 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, 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.
What Is Cenovus Energy’s Net Debt?
As you can see below, Cenovus Energy had CA$8.38b of debt at March 2019, down from CA$9.78b a year prior. However, because it has a cash reserve of CA$244.0m, its net debt is less, at about CA$8.14b.
How Strong Is Cenovus Energy’s Balance Sheet?
According to the last reported balance sheet, Cenovus Energy had liabilities of CA$3.07b due within 12 months, and liabilities of CA$15.5b due beyond 12 months. Offsetting these obligations, it had cash of CA$244.0m as well as receivables valued at CA$1.75b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CA$16.6b.
When you consider that this deficiency exceeds the company’s huge CA$14.4b 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. Because it carries more debt than cash, we think it’s worth watching Cenovus Energy’s balance sheet over time. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Cenovus Energy’s ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.
In the last year Cenovus Energy managed to grow its revenue by 17%, to CA$21b. We usually like to see faster growth from unprofitable companies, but each to their own.
Importantly, Cenovus Energy had negative earnings before interest and tax (EBIT), over the last year. To be specific the EBIT loss came in at CA$659m. When we look at that alongside the significant liabilities, we’re not particularly confident about the company. It would need to improve its operations quickly for us to be interested in it. For example, we would not want to see a repeat of last year’s loss of-CA$1.9b. And until that time we think this is a risky stock. For riskier companies like Cenovus Energy 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.
Of course, if you’re the type of investor who prefers buying stocks without the burden of debt, then don’t hesitate to discover our exclusive list of net cash growth stocks, today.
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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.