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. Importantly, Trinity Exploration & Production plc (LON:TRIN) does carry debt. But the real question is whether this debt is making the company risky.
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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
What Is Trinity Exploration & Production's Net Debt?
The chart below, which you can click on for greater detail, shows that Trinity Exploration & Production had US$2.70m in debt in June 2021; about the same as the year before. However, it does have US$19.0m in cash offsetting this, leading to net cash of US$16.3m.
How Healthy Is Trinity Exploration & Production's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Trinity Exploration & Production had liabilities of US$14.0m due within 12 months and liabilities of US$48.9m due beyond that. Offsetting this, it had US$19.0m in cash and US$8.23m in receivables that were due within 12 months. So its liabilities total US$35.7m more than the combination of its cash and short-term receivables.
This deficit isn't so bad because Trinity Exploration & Production is worth US$68.9m, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt. Despite its noteworthy liabilities, Trinity Exploration & Production 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, Trinity Exploration & Production turned things around in the last 12 months, delivering and EBIT of US$1.3m. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Trinity Exploration & Production 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.
Finally, a company can only pay off debt with cold hard cash, not accounting profits. Trinity Exploration & Production may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Over the last year, Trinity Exploration & Production recorded negative free cash flow, in total. Debt is usually more expensive, and almost always more risky in the hands of a company with negative free cash flow. Shareholders ought to hope for an improvement.
Although Trinity Exploration & Production'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$16.3m. So while Trinity Exploration & Production does not have a great balance sheet, it's certainly not too bad. 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. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for Trinity Exploration & Production you should know about.
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. 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.