Is Precision Drilling (TSE:PD) Using Debt In A Risky Way?

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We can see that Precision Drilling Corporation (TSE:PD) does use debt in its business. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Our analysis indicates that PD is potentially undervalued!

What Is Precision Drilling's Net Debt?

As you can see below, Precision Drilling had CA$1.14b of debt, at June 2022, which is about the same as the year before. You can click the chart for greater detail. However, because it has a cash reserve of CA$51.6m, its net debt is less, at about CA$1.09b.

A Look At Precision Drilling's Liabilities

According to the last reported balance sheet, Precision Drilling had liabilities of CA$283.2m due within 12 months, and liabilities of CA$1.24b due beyond 12 months. Offsetting this, it had CA$51.6m in cash and CA$316.5m in receivables that were due within 12 months. So its liabilities total CA$1.16b 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$1.14b, we think shareholders really should watch Precision Drilling's debt levels, like a parent watching their child ride a bike for the first time. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Precision Drilling'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.

Over 12 months, Precision Drilling reported revenue of CA$1.2b, which is a gain of 52%, although it did not report any earnings before interest and tax. 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. To be specific the EBIT loss came in at CA$93m. 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$134m. And until that time we think this is a risky stock. 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 1 warning sign for Precision Drilling 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.