Orca Energy Group (CVE:ORC.B) Seems To Use Debt Quite Sensibly

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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. We note that Orca Energy Group Inc. (CVE:ORC.B) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

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. 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 thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Orca Energy Group

What Is Orca Energy Group's Debt?

The image below, which you can click on for greater detail, shows that Orca Energy Group had debt of US$54.2m at the end of September 2020, a reduction from US$58.8m over a year. However, its balance sheet shows it holds US$98.5m in cash, so it actually has US$44.3m net cash.

A Look At Orca Energy Group's Liabilities

Zooming in on the latest balance sheet data, we can see that Orca Energy Group had liabilities of US$45.8m due within 12 months and liabilities of US$97.1m due beyond that. Offsetting this, it had US$98.5m in cash and US$21.8m in receivables that were due within 12 months. So its liabilities total US$22.6m more than the combination of its cash and short-term receivables.

Given Orca Energy Group has a market capitalization of US$159.3m, it's hard to believe these liabilities pose much threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. Despite its noteworthy liabilities, Orca Energy Group boasts net cash, so it's fair to say it does not have a heavy debt load!

The good news is that Orca Energy Group has increased its EBIT by 5.4% over twelve months, which should ease any concerns about debt repayment. 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 Orca Energy Group can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While Orca Energy Group has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Over the last three years, Orca Energy Group recorded free cash flow worth a fulsome 97% of its EBIT, which is stronger than we'd usually expect. That positions it well to pay down debt if desirable to do so.

Summing up

While Orca Energy Group does have more liabilities than liquid assets, it also has net cash of US$44.3m. And it impressed us with free cash flow of US$20m, being 97% of its EBIT. So we don't think Orca Energy Group's use of debt is risky. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 3 warning signs for Orca Energy Group (1 is a bit concerning) you should be aware of.

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.

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