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. Importantly, Precision Drilling Corporation (TSE:PD) does carry debt. But the real question is whether this debt is making the company risky.
When Is Debt Dangerous?
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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.
What Is Precision Drilling's Debt?
As you can see below, Precision Drilling had CA$1.19b of debt at March 2021, down from CA$1.50b a year prior. On the flip side, it has CA$77.8m in cash leading to net debt of about CA$1.11b.
How Strong Is Precision Drilling's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Precision Drilling had liabilities of CA$162.7m due within 12 months and liabilities of CA$1.27b due beyond that. On the other hand, it had cash of CA$77.8m and CA$220.9m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by CA$1.13b.
The deficiency here weighs heavily on the CA$695.7m company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we definitely think shareholders need to watch this one closely. After all, Precision Drilling would likely require a major re-capitalisation if it had to pay its creditors today. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Precision Drilling 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.
In the last year Precision Drilling had a loss before interest and tax, and actually shrunk its revenue by 47%, to CA$793m. That makes us nervous, to say the least.
While Precision Drilling'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$107m 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. For example, we would not want to see a repeat of last year's loss of CA$151m. In the meantime, we consider the stock to be risky. 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. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for Precision Drilling you should know about.
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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