Here's Why Parex Resources (TSE:PXT) Can Manage Its Debt Responsibly

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. Importantly, Parex Resources Inc. (TSE:PXT) does carry debt. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Parex Resources

What Is Parex Resources's Debt?

As you can see below, at the end of March 2024, Parex Resources had US$60.0m of debt, up from none a year ago. Click the image for more detail. But on the other hand it also has US$61.1m in cash, leading to a US$1.05m net cash position.

A Look At Parex Resources' Liabilities

Zooming in on the latest balance sheet data, we can see that Parex Resources had liabilities of US$220.2m due within 12 months and liabilities of US$163.1m due beyond that. On the other hand, it had cash of US$61.1m and US$167.4m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$154.9m.

Given Parex Resources has a market capitalization of US$1.68b, it's hard to believe these liabilities pose much threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. While it does have liabilities worth noting, Parex Resources also has more cash than debt, so we're pretty confident it can manage its debt safely.

The modesty of its debt load may become crucial for Parex Resources if management cannot prevent a repeat of the 29% cut to EBIT over the last year. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Parex Resources's ability to maintain a healthy balance sheet going forward. 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 business needs free cash flow to pay off debt; accounting profits just don't cut it. While Parex Resources has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Looking at the most recent three years, Parex Resources recorded free cash flow of 30% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

Summing Up

While it is always sensible to look at a company's total liabilities, it is very reassuring that Parex Resources has US$1.05m in net cash. So we don't have any problem with Parex Resources's use of debt. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. We've identified 3 warning signs with Parex Resources (at least 1 which doesn't sit too well with us) , and understanding them should be part of your investment process.

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.