Is Arrow Exploration (CVE:AXL) Using Too Much Debt?

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 might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We note that Arrow Exploration Corp. (CVE:AXL) does have debt on its balance sheet. But is this debt a concern to shareholders?

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

View 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 September 2020 Arrow Exploration had debt of US$5.52m, up from US$5.00m in one year. However, it also had US$254.8k in cash, and so its net debt is US$5.27m.

How Healthy Is Arrow Exploration's Balance Sheet?

We can see from the most recent balance sheet that Arrow Exploration had liabilities of US$16.2m falling due within a year, and liabilities of US$9.72m due beyond that. On the other hand, it had cash of US$254.8k and US$3.55m worth of receivables due within a year. So its liabilities total US$22.1m more than the combination of its cash and short-term receivables.

This deficit casts a shadow over the US$6.51m company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. After all, Arrow Exploration would likely require a major re-capitalisation if it had to pay its creditors today. When analysing debt levels, the balance sheet is the obvious place to start. 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.

In the last year Arrow Exploration had a loss before interest and tax, and actually shrunk its revenue by 59%, to US$11m. That makes us nervous, to say the least.

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$34m. If you consider the significant liabilities mentioned above, we are extremely wary of this investment. Of course, it may be able to improve its situation with a bit of luck and good execution. But we think that is unlikely since it is low on liquid assets, and made a loss of US$26m in the last year. So we think this stock is quite risky. We'd prefer to pass. 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. These risks can be hard to spot. Every company has them, and we've spotted 3 warning signs for Arrow Exploration (of which 2 shouldn't be ignored!) you should know about.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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. 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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