These 4 Measures Indicate That Petrus Resources (TSE:PRQ) Is Using Debt Extensively

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 Petrus Resources Ltd. (TSE:PRQ) makes use of debt. But should shareholders be worried about its use of debt?

This technology could replace computers: discover the 20 stocks are working to make quantum computing a reality.

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. When we examine debt levels, we first consider both cash and debt levels, together.

What Is Petrus Resources's Debt?

As you can see below, at the end of December 2024, Petrus Resources had CA$57.7m of debt, up from CA$49.4m a year ago. Click the image for more detail. However, it does have CA$2.06m in cash offsetting this, leading to net debt of about CA$55.7m.

A Look At Petrus Resources' Liabilities

According to the last reported balance sheet, Petrus Resources had liabilities of CA$51.3m due within 12 months, and liabilities of CA$65.5m due beyond 12 months. Offsetting this, it had CA$2.06m in cash and CA$11.6m in receivables that were due within 12 months. So it has liabilities totalling CA$103.1m more than its cash and near-term receivables, combined.

This deficit is considerable relative to its market capitalization of CA$158.1m, so it does suggest shareholders should keep an eye on Petrus Resources' use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.

See our latest analysis for Petrus Resources

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Given net debt is only 1.2 times EBITDA, it is initially surprising to see that Petrus Resources's EBIT has low interest coverage of 0.76 times. So one way or the other, it's clear the debt levels are not trivial. Importantly, Petrus Resources's EBIT fell a jaw-dropping 87% in the last twelve months. If that earnings trend continues then paying off its debt will be about as easy as herding cats on to a roller coaster. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Petrus Resources's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend .

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we always check how much of that EBIT is translated into free cash flow. In the last three years, Petrus Resources created free cash flow amounting to 17% of its EBIT, an uninspiring performance. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.

Our View

To be frank both Petrus Resources's interest cover and its track record of (not) growing its EBIT make us rather uncomfortable with its debt levels. But on the bright side, its net debt to EBITDA is a good sign, and makes us more optimistic. We're quite clear that we consider Petrus Resources to be really rather risky, as a result of its balance sheet health. For this reason we're pretty cautious about the stock, and we think shareholders should keep a close eye on its liquidity. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For example - Petrus Resources has 1 warning sign we think you should be aware of.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.