Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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 Precision Drilling Corporation (TSE:PD) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.
When Is Debt A Problem?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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.
View our latest analysis for Precision Drilling
What Is Precision Drilling's Net Debt?
As you can see below, Precision Drilling had CA$1.18b of debt, at March 2022, which is about the same as the year before. You can click the chart for greater detail. On the flip side, it has CA$24.1m in cash leading to net debt of about CA$1.15b.
A Look At Precision Drilling's Liabilities
We can see from the most recent balance sheet that Precision Drilling had liabilities of CA$230.2m falling due within a year, and liabilities of CA$1.27b due beyond that. On the other hand, it had cash of CA$24.1m and CA$344.2m worth of receivables due within a year. So its liabilities total CA$1.13b more than the combination of its cash and short-term receivables.
Given this deficit is actually higher than the company's market capitalization of CA$991.5m, we think shareholders really should watch Precision Drilling's debt levels, like a parent watching their child ride a bike for the first time. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer extensive dilution. 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 Precision Drilling 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.
In the last year Precision Drilling wasn't profitable at an EBIT level, but managed to grow its revenue by 39%, to CA$1.1b. With any luck the company will be able to grow its way to profitability.
Caveat Emptor
Even though Precision Drilling managed to grow its top line quite deftly, the cold hard truth is that it is losing money on the EBIT line. Its EBIT loss was a whopping CA$119m. When we look at that alongside the significant liabilities, we're not particularly confident about the company. We'd want to see some strong near-term improvements before getting too interested in the stock. Not least because it had negative free cash flow of CA$45m over the last twelve months. That means it's on the risky side of things. 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 4 warning signs for Precision Drilling you should know about.
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.
About TSX:PD
Precision Drilling
A drilling company, provides onshore drilling, completion, and production services to exploration and production companies in the oil and natural gas and geothermal industries in North America and the Middle East.
Very undervalued with proven track record.
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