Does Obsidian Energy (TSE:OBE) Have A Healthy Balance Sheet?

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. As with many other companies Obsidian Energy Ltd. (TSE:OBE) makes use of debt. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. 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, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Obsidian Energy

How Much Debt Does Obsidian Energy Carry?

You can click the graphic below for the historical numbers, but it shows that as of September 2024 Obsidian Energy had CA$342.1m of debt, an increase on CA$230.7m, over one year. And it doesn't have much cash, so its net debt is about the same.

A Look At Obsidian Energy's Liabilities

Zooming in on the latest balance sheet data, we can see that Obsidian Energy had liabilities of CA$249.7m due within 12 months and liabilities of CA$447.4m due beyond that. Offsetting this, it had CA$900.0k in cash and CA$87.8m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CA$608.4m.

This deficit is considerable relative to its market capitalization of CA$621.7m, so it does suggest shareholders should keep an eye on Obsidian Energy's use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

While Obsidian Energy's low debt to EBITDA ratio of 0.77 suggests only modest use of debt, the fact that EBIT only covered the interest expense by 5.7 times last year does give us pause. So we'd recommend keeping a close eye on the impact financing costs are having on the business. Shareholders should be aware that Obsidian Energy's EBIT was down 63% last year. If that decline continues then paying off debt will be harder than selling foie gras at a vegan convention. 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 Obsidian Energy can strengthen its balance sheet over time. 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. So it's worth checking how much of that EBIT is backed by free cash flow. In the last three years, Obsidian Energy created free cash flow amounting to 9.1% of its EBIT, an uninspiring performance. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.

Our View

Mulling over Obsidian Energy's attempt at (not) growing its EBIT, we're certainly not enthusiastic. But at least it's pretty decent at managing its debt, based on its EBITDA,; that's encouraging. Overall, it seems to us that Obsidian Energy's balance sheet is really quite a risk to the business. So we're almost as wary of this stock as a hungry kitten is about falling into its owner's fish pond: once bitten, twice shy, as they say. 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. For instance, we've identified 1 warning sign for Obsidian Energy that you should be aware of.

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.