Is Navitas Petroleum Limited Partnership (TLV:NVPT) 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. We note that Navitas Petroleum, Limited Partnership (TLV:NVPT) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. 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

How Much Debt Does Navitas Petroleum Limited Partnership Carry?

You can click the graphic below for the historical numbers, but it shows that as of June 2023 Navitas Petroleum Limited Partnership had US$542.7m of debt, an increase on US$424.7m, over one year. However, because it has a cash reserve of US$71.1m, its net debt is less, at about US$471.5m.

A Look At Navitas Petroleum Limited Partnership's Liabilities

The latest balance sheet data shows that Navitas Petroleum Limited Partnership had liabilities of US$28.5m due within a year, and liabilities of US$583.3m falling due after that. Offsetting these obligations, it had cash of US$71.1m as well as receivables valued at US$7.52m due within 12 months. So its liabilities total US$533.1m more than the combination of its cash and short-term receivables.

This is a mountain of leverage relative to its market capitalization of US$787.0m. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Navitas Petroleum Limited Partnership has a rather high debt to EBITDA ratio of 10.6 which suggests a meaningful debt load. But the good news is that it boasts fairly comforting interest cover of 4.3 times, suggesting it can responsibly service its obligations. Even worse, Navitas Petroleum Limited Partnership saw its EBIT tank 50% over the last 12 months. If earnings keep going like that over the long term, it has a snowball's chance in hell of paying off that debt. 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 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 we always check how much of that EBIT is translated into free cash flow. During the last three years, Navitas Petroleum 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, Navitas Petroleum Limited Partnership's conversion of EBIT to free cash flow left us tentative about the stock, and its EBIT growth rate was no more enticing than the one empty restaurant on the busiest night of the year. Having said that, its ability to cover its interest expense with its EBIT isn't such a worry. Taking into account all the aforementioned factors, it looks like Navitas Petroleum Limited Partnership has too much debt. While some investors love that sort of risky play, it's certainly not our cup of tea. 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 example - Navitas Petroleum Limited Partnership has 2 warning signs we think 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.