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

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. We note that International Petroleum Corporation (TSE:IPCO) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

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. The first step when considering a company's debt levels is to consider its 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$306.6m in debt in June 2023; about the same as the year before. However, it does have US$374.2m in cash offsetting this, leading to net cash of US$67.5m.

How Strong Is International Petroleum's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that International Petroleum had liabilities of US$142.3m due within 12 months and liabilities of US$598.8m due beyond that. Offsetting this, it had US$374.2m in cash and US$86.8m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$280.2m.

This deficit isn't so bad because International Petroleum is worth US$1.23b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt. 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.

But the bad news is that International Petroleum has seen its EBIT plunge 17% in the last twelve months. We think hat kind of performance, if repeated frequently, could well lead to difficulties for the stock. 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 want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. International Petroleum 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. During the last two years, International Petroleum generated free cash flow amounting to a very robust 84% of its EBIT, more than we'd expect. That positions it well to pay down debt if desirable to do so.

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$67.5m. The cherry on top was that in converted 84% of that EBIT to free cash flow, bringing in US$222m. So we are not troubled with International Petroleum's debt use. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that International Petroleum is showing 1 warning sign in our investment analysis , 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. 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.