Health Check: How Prudently Does Oceanic Iron Ore (CVE:FEO) Use Debt?

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. Importantly, Oceanic Iron Ore Corp. (CVE:FEO) does carry debt. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Oceanic Iron Ore

What Is Oceanic Iron Ore's Debt?

As you can see below, at the end of March 2023, Oceanic Iron Ore had CA$5.45m of debt, up from CA$4.05m a year ago. Click the image for more detail. However, it also had CA$578.2k in cash, and so its net debt is CA$4.87m.

How Healthy Is Oceanic Iron Ore's Balance Sheet?

According to the last reported balance sheet, Oceanic Iron Ore had liabilities of CA$1.97m due within 12 months, and liabilities of CA$4.68m due beyond 12 months. Offsetting these obligations, it had cash of CA$578.2k as well as receivables valued at CA$6.3k due within 12 months. So it has liabilities totalling CA$6.07m more than its cash and near-term receivables, combined.

This is a mountain of leverage relative to its market capitalization of CA$7.26m. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry. 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 Oceanic Iron Ore 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.

Given its lack of meaningful operating revenue, investors are probably hoping that Oceanic Iron Ore finds some valuable resources, before it runs out of money.

Caveat Emptor

Over the last twelve months Oceanic Iron Ore produced an earnings before interest and tax (EBIT) loss. Indeed, it lost CA$526k 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. So we think its balance sheet is a little strained, though not beyond repair. Another cause for caution is that is bled CA$698k in negative free cash flow over the last twelve months. So suffice it to say we consider the stock very risky. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that Oceanic Iron Ore is showing 5 warning signs in our investment analysis , and 4 of those don't sit too well with us...

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. 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.