We Think Arrow Exploration (CVE:AXL) Is Taking Some Risk With Its Debt

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says '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. We note that Arrow Exploration Corp. (CVE:AXL) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. If things get really bad, the lenders can take control of the business. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Arrow Exploration

What Is Arrow Exploration's Net Debt?

You can click the graphic below for the historical numbers, but it shows that Arrow Exploration had US$3.47m of debt in March 2022, down from US$6.06m, one year before. However, it does have US$9.38m in cash offsetting this, leading to net cash of US$5.91m.

A Look At Arrow Exploration's Liabilities

The latest balance sheet data shows that Arrow Exploration had liabilities of US$3.88m due within a year, and liabilities of US$17.4m falling due after that. Offsetting this, it had US$9.38m in cash and US$1.16m in receivables that were due within 12 months. So its liabilities total US$10.7m more than the combination of its cash and short-term receivables.

Arrow Exploration has a market capitalization of US$43.5m, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution. Despite its noteworthy liabilities, Arrow Exploration boasts net cash, so it's fair to say it does not have a heavy debt load!

We also note that Arrow Exploration improved its EBIT from a last year's loss to a positive US$3.7m. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Arrow Exploration 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Arrow Exploration may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Over the last year, Arrow Exploration saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.

Summing Up

Although Arrow Exploration'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$5.91m. So although we see some areas for improvement, we're not too worried about Arrow Exploration's balance sheet. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. To that end, you should learn about the 4 warning signs we've spotted with Arrow Exploration (including 2 which are concerning) .

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.