These 4 Measures Indicate That Delek Drilling - Limited Partnership (TLV:DEDR.L) Is Using Debt Extensively

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.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. Importantly, Delek Drilling - Limited Partnership (TLV:DEDR.L) does carry debt. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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.

See our latest analysis for Delek Drilling - Limited Partnership

How Much Debt Does Delek Drilling - Limited Partnership Carry?

You can click the graphic below for the historical numbers, but it shows that as of September 2020 Delek Drilling - Limited Partnership had US$3.33b of debt, an increase on US$3.15b, over one year. However, it does have US$322.0m in cash offsetting this, leading to net debt of about US$3.01b.

A Look At Delek Drilling - Limited Partnership's Liabilities

Zooming in on the latest balance sheet data, we can see that Delek Drilling - Limited Partnership had liabilities of US$231.7m due within 12 months and liabilities of US$3.43b due beyond that. On the other hand, it had cash of US$322.0m and US$227.0m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$3.11b.

This deficit casts a shadow over the US$1.61b company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. After all, Delek Drilling - Limited Partnership would likely require a major re-capitalisation if it had to pay its creditors today.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Delek Drilling - Limited Partnership has a rather high debt to EBITDA ratio of 5.3 which suggests a meaningful debt load. However, its interest coverage of 5.7 is reasonably strong, which is a good sign. Importantly, Delek Drilling - Limited Partnership grew its EBIT by 87% over the last twelve months, and that growth will make it easier to handle its debt. There's no doubt that we learn most about debt from the balance sheet. But it is Delek Drilling - Limited Partnership'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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. During the last three years, Delek Drilling - Limited Partnership burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

On the face of it, Delek Drilling - Limited Partnership's conversion of EBIT to free cash flow left us tentative about the stock, and its level of total liabilities was no more enticing than the one empty restaurant on the busiest night of the year. But on the bright side, its EBIT growth rate is a good sign, and makes us more optimistic. We're quite clear that we consider Delek Drilling - Limited Partnership to be really rather risky, as a result of its balance sheet health. So we're almost as wary of this stock as a hungry kitten is about falling into its owner's fish pond: once bitten, twice shy, as they say. 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. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for Delek Drilling - Limited Partnership (of which 1 is potentially serious!) 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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