Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. As with many other companies Tethys Petroleum Limited (CVE:TPL) makes use of debt. 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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.
What Is Tethys Petroleum's Net Debt?
The image below, which you can click on for greater detail, shows that Tethys Petroleum had debt of US$6.30m at the end of September 2021, a reduction from US$9.57m over a year. However, because it has a cash reserve of US$658.0k, its net debt is less, at about US$5.64m.
How Strong Is Tethys Petroleum's Balance Sheet?
We can see from the most recent balance sheet that Tethys Petroleum had liabilities of US$20.1m falling due within a year, and liabilities of US$13.1m due beyond that. Offsetting these obligations, it had cash of US$658.0k as well as receivables valued at US$3.25m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$29.3m.
Tethys Petroleum has a market capitalization of US$55.1m, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Tethys Petroleum's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.
Over 12 months, Tethys Petroleum reported revenue of US$11m, which is a gain of 14%, although it did not report any earnings before interest and tax. That rate of growth is a bit slow for our taste, but it takes all types to make a world.
Over the last twelve months Tethys Petroleum produced an earnings before interest and tax (EBIT) loss. Its EBIT loss was a whopping US$39m. When we look at that and recall the liabilities on its balance sheet, relative to cash, it seems unwise to us for the company to have any debt. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. However, it doesn't help that it burned through US$8.5m of cash over the last year. So in short it's a really risky stock. 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. For example, we've discovered 4 warning signs for Tethys Petroleum that you should be aware of before investing here.
Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.
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.
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