Is Vital Energy (CVE:VUX) Using Debt 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.' 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. We can see that Vital Energy Inc. (CVE:VUX) does use debt in its business. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

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. 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for Vital Energy

What Is Vital Energy's Net Debt?

The image below, which you can click on for greater detail, shows that at March 2021 Vital Energy had debt of CA$3.86m, up from none in one year. However, it does have CA$635.2k in cash offsetting this, leading to net debt of about CA$3.23m.

How Healthy Is Vital Energy's Balance Sheet?

We can see from the most recent balance sheet that Vital Energy had liabilities of CA$1.93m falling due within a year, and liabilities of CA$5.44m due beyond that. Offsetting this, it had CA$635.2k in cash and CA$881.5k in receivables that were due within 12 months. So it has liabilities totalling CA$5.85m more than its cash and near-term receivables, combined.

Given this deficit is actually higher than the company's market capitalization of CA$4.52m, we think shareholders really should watch Vital Energy's debt levels, like a parent watching their child ride a bike for the first time. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer extensive dilution. There's no doubt that we learn most about debt from the balance sheet. But it is Vital Energy's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

In the last year Vital Energy had a loss before interest and tax, and actually shrunk its revenue by 36%, to CA$4.1m. To be frank that doesn't bode well.

Caveat Emptor

While Vital Energy's falling revenue is about as heartwarming as a wet blanket, arguably its earnings before interest and tax (EBIT) loss is even less appealing. Indeed, it lost a very considerable CA$7.0m at the EBIT level. Considering that alongside the liabilities mentioned above make us nervous about the company. It would need to improve its operations quickly for us to be interested in it. Not least because it burned through CA$1.5m in negative free cash flow over the last year. That means it's on the risky side of things. 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. For example, we've discovered 4 warning signs for Vital Energy (3 are a bit concerning!) that you should be aware of before investing here.

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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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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