Warren Buffett famously said, '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. As with many other companies PetroTal Corp. (CVE:TAL) makes use of debt. But should shareholders be worried about its use of debt?
When Is Debt Dangerous?
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. If things get really bad, the lenders can take control of the business. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.
What Is PetroTal's Debt?
As you can see below, at the end of June 2020, PetroTal had US$3.05m of debt, up from none a year ago. Click the image for more detail. But on the other hand it also has US$14.7m in cash, leading to a US$11.6m net cash position.
A Look At PetroTal's Liabilities
Zooming in on the latest balance sheet data, we can see that PetroTal had liabilities of US$76.9m due within 12 months and liabilities of US$17.2m due beyond that. Offsetting this, it had US$14.7m in cash and US$18.3m in receivables that were due within 12 months. So its liabilities total US$61.2m more than the combination of its cash and short-term receivables.
This deficit is considerable relative to its market capitalization of US$94.4m, so it does suggest shareholders should keep an eye on PetroTal's use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution. Despite its noteworthy liabilities, PetroTal boasts net cash, so it's fair to say it does not have a heavy debt load!
It was also good to see that despite losing money on the EBIT line last year, PetroTal turned things around in the last 12 months, delivering and EBIT of US$8.3m. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if PetroTal 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.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While PetroTal 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. During the last year, PetroTal burned a lot of cash. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.
Although PetroTal'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$11.6m. So although we see some areas for improvement, we're not too worried about PetroTal's balance sheet. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. Like risks, for instance. Every company has them, and we've spotted 4 warning signs for PetroTal (of which 1 shouldn't be ignored!) you should know about.
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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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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