Is Harbour Energy (LON:HBR) 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.' 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 Harbour Energy plc (LON:HBR) does use debt in its business. But is this debt a concern to shareholders?

When Is Debt A Problem?

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. If things get really bad, the lenders can take control of the business. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Harbour Energy

How Much Debt Does Harbour Energy Carry?

As you can see below, Harbour Energy had US$501.0m of debt, at June 2024, which is about the same as the year before. You can click the chart for greater detail. However, its balance sheet shows it holds US$539.0m in cash, so it actually has US$38.0m net cash.

How Healthy Is Harbour Energy's Balance Sheet?

The latest balance sheet data shows that Harbour Energy had liabilities of US$2.04b due within a year, and liabilities of US$6.39b falling due after that. Offsetting these obligations, it had cash of US$539.0m as well as receivables valued at US$852.0m due within 12 months. So it has liabilities totalling US$7.03b more than its cash and near-term receivables, combined.

Given this deficit is actually higher than the company's market capitalization of US$4.98b, we think shareholders really should watch Harbour 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. Harbour Energy boasts net cash, so it's fair to say it does not have a heavy debt load, even if it does have very significant liabilities, in total.

It is just as well that Harbour Energy's load is not too heavy, because its EBIT was down 65% over the last year. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Harbour Energy's ability to maintain a healthy balance sheet going forward. 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 Harbour Energy 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. Happily for any shareholders, Harbour Energy actually produced more free cash flow than EBIT over the last three years. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Summing Up

Although Harbour Energy'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$38.0m. The cherry on top was that in converted 123% of that EBIT to free cash flow, bringing in US$799m. So although we see some areas for improvement, we're not too worried about Harbour Energy's balance sheet. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 2 warning signs for Harbour Energy (1 is concerning) you should be aware of.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.