Is Cenovus Energy (TSE:CVE) Using Debt In A Risky Way?

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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 note that Cenovus Energy Inc. (TSE:CVE) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Cenovus Energy

What Is Cenovus Energy's Net Debt?

As you can see below, at the end of June 2020, Cenovus Energy had CA$8.38b of debt, up from CA$7.15b a year ago. Click the image for more detail. And it doesn't have much cash, so its net debt is about the same.

A Look At Cenovus Energy's Liabilities

Zooming in on the latest balance sheet data, we can see that Cenovus Energy had liabilities of CA$2.16b due within 12 months and liabilities of CA$14.4b due beyond that. Offsetting these obligations, it had cash of CA$152.0m as well as receivables valued at CA$1.40b due within 12 months. So it has liabilities totalling CA$15.1b more than its cash and near-term receivables, combined.

This deficit casts a shadow over the CA$7.45b company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. After all, Cenovus Energy would likely require a major re-capitalisation if it had to pay its creditors today. 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.

Over 12 months, Cenovus Energy made a loss at the EBIT level, and saw its revenue drop to CA$16b, which is a fall of 25%. To be frank that doesn't bode well.

Caveat Emptor

While Cenovus Energy's falling revenue is about as heartwarming as a wet blanket, arguably its earnings before interest and tax (EBIT) loss is even less appealing. Indeed, it lost a very considerable CA$1.6b at the EBIT level. Considering that alongside the liabilities mentioned above make us nervous about the company. We'd want to see some strong near-term improvements before getting too interested in the stock. Not least because it had negative free cash flow of CA$204.0m over the last twelve months. So suffice it to say we consider the stock to be risky. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. Like risks, for instance. Every company has them, and we've spotted 2 warning signs for Cenovus Energy (of which 1 shouldn't be ignored!) you should know about.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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. 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.
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