Tourmaline Oil (TSE:TOU) Seems To Use Debt Quite Sensibly

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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 can see that Tourmaline Oil Corp. (TSE:TOU) does use debt in its business. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Tourmaline Oil

How Much Debt Does Tourmaline Oil Carry?

You can click the graphic below for the historical numbers, but it shows that as of June 2024 Tourmaline Oil had CA$1.41b of debt, an increase on CA$587.1m, over one year. However, because it has a cash reserve of CA$70.0m, its net debt is less, at about CA$1.34b.

How Strong Is Tourmaline Oil's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Tourmaline Oil had liabilities of CA$981.8m due within 12 months and liabilities of CA$4.86b due beyond that. Offsetting these obligations, it had cash of CA$70.0m as well as receivables valued at CA$620.8m due within 12 months. So it has liabilities totalling CA$5.15b more than its cash and near-term receivables, combined.

While this might seem like a lot, it is not so bad since Tourmaline Oil has a huge market capitalization of CA$20.6b, 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.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Tourmaline Oil's net debt is only 0.40 times its EBITDA. And its EBIT easily covers its interest expense, being 41.3 times the size. So you could argue it is no more threatened by its debt than an elephant is by a mouse. It is just as well that Tourmaline Oil's load is not too heavy, because its EBIT was down 47% over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. 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 Tourmaline Oil 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.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So we always check how much of that EBIT is translated into free cash flow. During the last three years, Tourmaline Oil produced sturdy free cash flow equating to 63% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Our View

Tourmaline Oil's EBIT growth rate was a real negative on this analysis, although the other factors we considered were considerably better. There's no doubt that its ability to to cover its interest expense with its EBIT is pretty flash. When we consider all the elements mentioned above, it seems to us that Tourmaline Oil is managing its debt quite well. But a word of caution: we think debt levels are high enough to justify ongoing monitoring. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. We've identified 3 warning signs with Tourmaline Oil , and understanding them should be part of your investment process.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.