Is Cenovus Energy (TSE:CVE) A Risky Investment?

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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 Cenovus Energy Inc. (TSE:CVE) does use debt in its business. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, 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.

See our latest analysis for Cenovus Energy

How Much Debt Does Cenovus Energy Carry?

The image below, which you can click on for greater detail, shows that Cenovus Energy had debt of CA$7.41b at the end of June 2024, a reduction from CA$8.53b over a year. However, it does have CA$3.15b in cash offsetting this, leading to net debt of about CA$4.26b.

How Healthy Is Cenovus Energy's Balance Sheet?

We can see from the most recent balance sheet that Cenovus Energy had liabilities of CA$7.03b falling due within a year, and liabilities of CA$18.9b due beyond that. Offsetting these obligations, it had cash of CA$3.15b as well as receivables valued at CA$3.89b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CA$18.9b.

While this might seem like a lot, it is not so bad since Cenovus Energy has a huge market capitalization of CA$49.8b, and so it could probably strengthen its balance sheet by raising capital if it needed to. However, it is still worthwhile taking a close look at its ability to pay off debt.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Cenovus Energy's net debt is only 0.38 times its EBITDA. And its EBIT easily covers its interest expense, being 21.1 times the size. So we're pretty relaxed about its super-conservative use of debt. Another good sign is that Cenovus Energy has been able to increase its EBIT by 27% in twelve months, making it easier to pay down debt. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Cenovus Energy can strengthen its balance sheet over time. 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. So it's worth checking how much of that EBIT is backed by free cash flow. During the last three years, Cenovus Energy produced sturdy free cash flow equating to 79% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Our View

Happily, Cenovus Energy's impressive interest cover implies it has the upper hand on its debt. And that's just the beginning of the good news since its conversion of EBIT to free cash flow is also very heartening. Zooming out, Cenovus Energy seems to use debt quite reasonably; and that gets the nod from us. While debt does bring risk, when used wisely it can also bring a higher return on equity. 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. Case in point: We've spotted 3 warning signs for Cenovus Energy you should be aware of, and 1 of them is a bit concerning.

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.