Here's Why Arrow Exploration (CVE:AXL) Can Afford Some Debt

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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. As with many other companies Arrow Exploration Corp. (CVE:AXL) makes use of debt. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

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. 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. 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. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Arrow Exploration

What Is Arrow Exploration's Debt?

The image below, which you can click on for greater detail, shows that at June 2021 Arrow Exploration had debt of US$6.17m, up from US$5.70m in one year. On the flip side, it has US$4.77m in cash leading to net debt of about US$1.40m.

How Healthy Is Arrow Exploration's Balance Sheet?

According to the last reported balance sheet, Arrow Exploration had liabilities of US$5.63m due within 12 months, and liabilities of US$9.05m due beyond 12 months. On the other hand, it had cash of US$4.77m and US$2.65m worth of receivables due within a year. So its liabilities total US$7.26m more than the combination of its cash and short-term receivables.

Given Arrow Exploration has a market capitalization of US$58.2m, 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. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Arrow Exploration'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.

Over 12 months, Arrow Exploration made a loss at the EBIT level, and saw its revenue drop to US$2.4m, which is a fall of 86%. To be frank that doesn't bode well.

Caveat Emptor

While Arrow Exploration's falling revenue is about as heartwarming as a wet blanket, arguably its earnings before interest and tax (EBIT) loss is even less appealing. Its EBIT loss was a whopping US$6.2m. Considering that alongside the liabilities mentioned above does not give us much confidence that company should be using so much debt. So we think its balance sheet is a little strained, though not beyond repair. However, it doesn't help that it burned through US$6.2m of cash over the last year. So in short it's a really risky stock. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For example Arrow Exploration has 6 warning signs (and 2 which are a bit unpleasant) we think you should know about.

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.

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.

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