Stock Analysis

These 4 Measures Indicate That Suncor Energy (TSE:SU) Is Using Debt Reasonably Well

TSX:SU
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David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' 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 Suncor Energy Inc. (TSE:SU) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

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. If things get really bad, the lenders can take control of the business. 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, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.

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What Is Suncor Energy's Net Debt?

The image below, which you can click on for greater detail, shows that Suncor Energy had debt of CA$13.8b at the end of June 2023, a reduction from CA$14.5b over a year. On the flip side, it has CA$2.61b in cash leading to net debt of about CA$11.2b.

debt-equity-history-analysis
TSX:SU Debt to Equity History September 16th 2023

How Healthy Is Suncor Energy's Balance Sheet?

We can see from the most recent balance sheet that Suncor Energy had liabilities of CA$12.0b falling due within a year, and liabilities of CA$32.2b due beyond that. Offsetting this, it had CA$2.61b in cash and CA$6.47b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CA$35.1b.

While this might seem like a lot, it is not so bad since Suncor Energy has a huge market capitalization of CA$61.1b, and so it could probably strengthen its balance sheet by raising capital if it needed to. However, it is still worthwhile taking a close look at its ability to pay off debt.

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.

Suncor Energy has a low net debt to EBITDA ratio of only 0.54. And its EBIT covers its interest expense a whopping 15.9 times over. So you could argue it is no more threatened by its debt than an elephant is by a mouse. But the other side of the story is that Suncor Energy saw its EBIT decline by 5.6% over the last year. If earnings continue to decline at that rate the company may have increasing difficulty managing its debt load. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Suncor Energy 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Over the most recent three years, Suncor Energy recorded free cash flow worth 73% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Our View

Suncor Energy's interest cover was a real positive on this analysis, as was its conversion of EBIT to free cash flow. On the other hand, its EBIT growth rate makes us a little less comfortable about its debt. When we consider all the elements mentioned above, it seems to us that Suncor Energy is managing its debt quite well. But a word of caution: we think debt levels are high enough to justify ongoing monitoring. 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. For example, we've discovered 4 warning signs for Suncor Energy (1 is a bit concerning!) that you should be aware of before investing here.

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.

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Find out whether Suncor Energy is potentially over or undervalued by checking out our comprehensive analysis, which includes fair value estimates, risks and warnings, dividends, insider transactions and financial health.

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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.