Here's Why PetroTal (TSE:TAL) Can Manage Its Debt Responsibly

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.' 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 PetroTal Corp. (TSE:TAL) makes use of debt. But should shareholders be worried about its use of debt?

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Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

What Is PetroTal's Debt?

You can click the graphic below for the historical numbers, but it shows that as of December 2024 PetroTal had US$10.0m of debt, an increase on none, over one year. But it also has US$102.8m in cash to offset that, meaning it has US$92.7m net cash.

How Strong Is PetroTal's Balance Sheet?

We can see from the most recent balance sheet that PetroTal had liabilities of US$135.2m falling due within a year, and liabilities of US$163.8m due beyond that. Offsetting this, it had US$102.8m in cash and US$88.9m in receivables that were due within 12 months. So it has liabilities totalling US$107.3m more than its cash and near-term receivables, combined.

While this might seem like a lot, it is not so bad since PetroTal has a market capitalization of US$373.0m, 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. While it does have liabilities worth noting, PetroTal also has more cash than debt, so we're pretty confident it can manage its debt safely.

Check out our latest analysis for PetroTal

On the other hand, PetroTal saw its EBIT drop by 2.3% in the last twelve months. If earnings continue to decline at that rate the company may have increasing difficulty managing its debt load. 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 PetroTal 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While PetroTal 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. During the last three years, PetroTal produced sturdy free cash flow equating to 51% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing Up

Although PetroTal's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of US$92.7m. So we don't have any problem with PetroTal's use of debt. 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, we've discovered 3 warning signs for PetroTal (1 is a bit concerning!) that you should be aware of before investing here.

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.