These 4 Measures Indicate That Navitas Petroleum Limited Partnership (TLV:NVPT.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 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 note that Navitas Petroleum, Limited Partnership (TLV:NVPT.L) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. 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 Navitas Petroleum Limited Partnership

What Is Navitas Petroleum Limited Partnership's Debt?

You can click the graphic below for the historical numbers, but it shows that as of December 2020 Navitas Petroleum Limited Partnership had US$327.7m of debt, an increase on US$239.3m, over one year. However, it does have US$114.8m in cash offsetting this, leading to net debt of about US$212.9m.

A Look At Navitas Petroleum Limited Partnership's Liabilities

Zooming in on the latest balance sheet data, we can see that Navitas Petroleum Limited Partnership had liabilities of US$188.7m due within 12 months and liabilities of US$166.7m due beyond that. On the other hand, it had cash of US$114.8m and US$166.6m worth of receivables due within a year. So its liabilities total US$73.9m more than the combination of its cash and short-term receivables.

Navitas Petroleum Limited Partnership has a market capitalization of US$256.8m, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.

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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Weak interest cover of 0.12 times and a disturbingly high net debt to EBITDA ratio of 15.5 hit our confidence in Navitas Petroleum Limited Partnership like a one-two punch to the gut. The debt burden here is substantial. However, it should be some comfort for shareholders to recall that Navitas Petroleum Limited Partnership actually grew its EBIT by a hefty 587%, over the last 12 months. If it can keep walking that path it will be in a position to shed its debt with relative ease. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Navitas Petroleum Limited Partnership 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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So it's worth checking how much of that EBIT is backed by free cash flow. During the last two years, Navitas Petroleum Limited Partnership burned a lot of cash. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Our View

Neither Navitas Petroleum Limited Partnership's ability to convert EBIT to free cash flow nor its interest cover gave us confidence in its ability to take on more debt. But the good news is it seems to be able to grow its EBIT with ease. When we consider all the factors discussed, it seems to us that Navitas Petroleum Limited Partnership is taking some risks with its use of debt. So while that leverage does boost returns on equity, we wouldn't really want to see it increase from here. 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. Case in point: We've spotted 1 warning sign for Navitas Petroleum Limited Partnership 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. 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.
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