Is Trinity Exploration & Production (LON:TRIN) Using Too Much Debt?

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says '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, 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?

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. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Trinity Exploration & Production

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 December 2021; about the same as the year before. But it also has US$18.3m in cash to offset that, meaning it has US$15.6m net cash.

How Strong 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$15.1m due within 12 months and liabilities of US$57.8m due beyond that. On the other hand, it had cash of US$18.3m and US$9.85m worth of receivables due within a year. So its liabilities total US$44.7m more than the combination of its cash and short-term receivables.

This is a mountain of leverage relative to its market capitalization of US$67.7m. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution. Despite its noteworthy liabilities, Trinity Exploration & Production boasts net cash, so it's fair to say it does not have a heavy debt load!

Even more impressive was the fact that Trinity Exploration & Production grew its EBIT by 551% over twelve months. If maintained that growth will make the debt even more manageable in the years ahead. 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 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. While Trinity Exploration & Production 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 two years, Trinity Exploration & Production produced sturdy free cash flow equating to 70% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing up

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$15.6m. And we liked the look of last year's 551% year-on-year EBIT growth. So is Trinity Exploration & Production's debt a risk? It doesn't seem so to us. 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 instance, we've identified 2 warning signs for Trinity Exploration & Production (1 is a bit unpleasant) you should be aware of.

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.

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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.