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. 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 can see that Stampede Drilling Inc. (CVE:SDI) does use debt in its business. But should shareholders be worried about its use of debt?
What Risk Does Debt Bring?
Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. When we think about a company’s use of debt, we first look at cash and debt together.
What Is Stampede Drilling’s Debt?
As you can see below, at the end of September 2019, Stampede Drilling had CA$8.97m of debt, up from CA$3.1 a year ago. Click the image for more detail. However, it does have CA$384.0k in cash offsetting this, leading to net debt of about CA$8.59m.
A Look At Stampede Drilling’s Liabilities
We can see from the most recent balance sheet that Stampede Drilling had liabilities of CA$11.4m falling due within a year, and liabilities of CA$3.08m due beyond that. On the other hand, it had cash of CA$384.0k and CA$6.51m worth of receivables due within a year. So its liabilities total CA$7.61m more than the combination of its cash and short-term receivables.
Stampede Drilling has a market capitalization of CA$27.7m, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. The balance sheet is clearly the area to focus on when you are analysing debt. But you can’t view debt in total isolation; since Stampede Drilling will need earnings to service that debt. So when considering debt, it’s definitely worth looking at the earnings trend. Click here for an interactive snapshot.
In the last year Stampede Drilling wasn’t profitable at an EBIT level, but managed to grow its revenue by 86%, to CA$28m. Shareholders probably have their fingers crossed that it can grow its way to profits.
Despite the top line growth, Stampede Drilling still had negative earnings before interest and tax (EBIT), over the last year. Indeed, it lost CA$2.7m at the EBIT level. Considering that alongside the liabilities mentioned above does not give us much confidence that company should be using so much debt. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. Another cause for caution is that is bled CA$8.0m in negative free cash flow over the last twelve months. So in short it’s a really risky stock. 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. Be aware that Stampede Drilling is showing 5 warning signs in our investment analysis , and 2 of those are potentially serious…
At the end of the day, it’s often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It’s free.
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