Is Zargon Oil & Gas (TSE:ZAR) A Risky Investment?

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Legendary fund manager Li Lu (who Charlie Munger backed) once said, ‘The biggest investment risk is not the volatility of prices, but whether you will suffer a 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. Zargon Oil & Gas Ltd. (TSE:ZAR) makes use of debt. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. If things get really bad, the lenders can take control of the business. 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. 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.

View our latest analysis for Zargon Oil & Gas

What Is Zargon Oil & Gas’s Net Debt?

You can click the graphic below for the historical numbers, but it shows that Zargon Oil & Gas had CA$4.85m of debt in March 2019, down from CA$41.1m, one year before However, its balance sheet shows it holds CA$4.90m in cash, so it actually has CA$45.0k net cash.

TSX:ZAR Historical Debt, July 11th 2019
TSX:ZAR Historical Debt, July 11th 2019

How Healthy Is Zargon Oil & Gas’s Balance Sheet?

The latest balance sheet data shows that Zargon Oil & Gas had liabilities of CA$6.19m due within a year, and liabilities of CA$71.1m falling due after that. Offsetting these obligations, it had cash of CA$4.90m as well as receivables valued at CA$3.10m due within 12 months. So its liabilities total CA$69.3m more than the combination of its cash and short-term receivables.

This deficit casts a shadow over the CA$8.16m company, like a colossus towering over mere mortals. So we’d watch its balance sheet closely, without a doubt After all, Zargon Oil & Gas would likely require a major re-capitalisation if it had to pay its creditors today. Given that Zargon Oil & Gas has more cash than debt, we’re pretty confident it can manage its debt safely. When analysing debt levels, the balance sheet is the obvious place to start. But it is Zargon Oil & Gas’s earnings that will influence how the balance sheet holds up in the future. So when considering debt, it’s definitely worth looking at the earnings trend. Click here for an interactive snapshot.

In the last year Zargon Oil & Gas actually shrunk its revenue by 14%, to CA$29m. That’s not what we would hope to see.

So How Risky Is Zargon Oil & Gas?

By their very nature companies that are losing money are more risky than those with a long history of profitability. And in the last year Zargon Oil & Gas had negative earnings before interest and tax (EBIT), truth be told. Indeed, in that time it burnt through CA$4.0m of cash and made a loss of CA$6.0m. However, it has net cash of CA$4.9m, so it has a bit of time before it will need more capital. Summing up, we’re a little skeptical of this one, as it seems fairly risky in the absence of free cashflow. For riskier companies like Zargon Oil & Gas I always like to keep an eye on whether insiders are buying or selling. So click here if you want to find out for yourself.

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.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.