These 4 Measures Indicate That International Petroleum (TSE:IPCO) Is Using Debt Safely

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.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. Importantly, International Petroleum Corporation (TSE:IPCO) does carry debt. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. 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. 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.

Check out our latest analysis for International Petroleum

What Is International Petroleum's Debt?

The chart below, which you can click on for greater detail, shows that International Petroleum had US$307.2m in debt in March 2023; about the same as the year before. However, its balance sheet shows it holds US$378.5m in cash, so it actually has US$71.2m net cash.

How Healthy Is International Petroleum's Balance Sheet?

The latest balance sheet data shows that International Petroleum had liabilities of US$161.9m due within a year, and liabilities of US$603.5m falling due after that. Offsetting this, it had US$378.5m in cash and US$110.0m in receivables that were due within 12 months. So its liabilities total US$276.9m more than the combination of its cash and short-term receivables.

This deficit isn't so bad because International Petroleum is worth US$1.13b, and thus could probably raise enough capital to shore up 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. While it does have liabilities worth noting, International Petroleum also has more cash than debt, so we're pretty confident it can manage its debt safely.

In addition to that, we're happy to report that International Petroleum has boosted its EBIT by 64%, thus reducing the spectre of future debt repayments. 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 International Petroleum's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While International Petroleum has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Over the last two years, International Petroleum recorded free cash flow worth a fulsome 91% of its EBIT, which is stronger than we'd usually expect. That puts it in a very strong position to pay down debt.

Summing Up

Although International Petroleum's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of US$71.2m. The cherry on top was that in converted 91% of that EBIT to free cash flow, bringing in US$362m. So is International Petroleum's debt a risk? It doesn't seem so to us. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. These risks can be hard to spot. Every company has them, and we've spotted 1 warning sign for International Petroleum you should know about.

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.

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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.