Is Imperial Oil (TSE:IMO) A Risky Investment?

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. As with many other companies Imperial Oil Limited (TSE:IMO) makes use of debt. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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 Imperial Oil

What Is Imperial Oil's Net Debt?

As you can see below, Imperial Oil had CA$3.55b of debt at December 2022, down from CA$4.55b a year prior. But it also has CA$3.75b in cash to offset that, meaning it has CA$202.0m net cash.

How Healthy Is Imperial Oil's Balance Sheet?

We can see from the most recent balance sheet that Imperial Oil had liabilities of CA$8.90b falling due within a year, and liabilities of CA$12.2b due beyond that. On the other hand, it had cash of CA$3.75b and CA$4.72b worth of receivables due within a year. So it has liabilities totalling CA$12.6b more than its cash and near-term receivables, combined.

While this might seem like a lot, it is not so bad since Imperial Oil has a huge market capitalization of CA$40.9b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. While it does have liabilities worth noting, Imperial Oil also has more cash than debt, so we're pretty confident it can manage its debt safely.

Better yet, Imperial Oil grew its EBIT by 185% last year, which is an impressive improvement. That boost will make it even easier to pay down debt going forward. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Imperial Oil 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 company can only pay off debt with cold hard cash, not accounting profits. Imperial Oil may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Over the last two years, Imperial Oil actually produced more free cash flow than EBIT. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Summing Up

While Imperial Oil does have more liabilities than liquid assets, it also has net cash of CA$202.0m. And it impressed us with free cash flow of CA$9.0b, being 106% of its EBIT. So is Imperial Oil's debt a risk? It doesn't seem so to us. 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. For example, we've discovered 1 warning sign for Imperial Oil that you should be aware of before investing here.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.