ShaMaran Petroleum (CVE:SNM) Has A Somewhat Strained Balance Sheet

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. As with many other companies ShaMaran Petroleum Corp. (CVE:SNM) makes use of debt. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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 examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for ShaMaran Petroleum

How Much Debt Does ShaMaran Petroleum Carry?

You can click the graphic below for the historical numbers, but it shows that as of March 2021 ShaMaran Petroleum had US$203.4m of debt, an increase on US$189.6m, over one year. On the flip side, it has US$18.1m in cash leading to net debt of about US$185.3m.

How Healthy Is ShaMaran Petroleum's Balance Sheet?

We can see from the most recent balance sheet that ShaMaran Petroleum had liabilities of US$191.9m falling due within a year, and liabilities of US$38.2m due beyond that. Offsetting this, it had US$18.1m in cash and US$65.7m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$146.2m.

When you consider that this deficiency exceeds the company's US$114.7m market capitalization, you might well be inclined to review the balance sheet intently. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer extensive dilution.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

ShaMaran Petroleum's debt of just -2.0 times EBITDA is clearly modest. But strangely, EBIT was only 0.23 times interest expenses, suggesting the that may paint an overly pretty picture of the stock. Notably, ShaMaran Petroleum made a loss at the EBIT level, last year, but improved that to positive EBIT of US$5.4m in the last twelve months. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine ShaMaran Petroleum's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it is important to check how much of its earnings before interest and tax (EBIT) converts to actual free cash flow. Over the last year, ShaMaran Petroleum actually produced more free cash flow than EBIT. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Our View

We feel some trepidation about ShaMaran Petroleum's difficulty interest cover, but we've got positives to focus on, too. To wit both its net debt to EBITDA and conversion of EBIT to free cash flow were encouraging signs. We think that ShaMaran Petroleum's debt does make it a bit risky, after considering the aforementioned data points together. Not all risk is bad, as it can boost share price returns if it pays off, but this debt risk is worth keeping in mind. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. To that end, you should be aware of the 1 warning sign we've spotted with ShaMaran Petroleum .

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. 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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