Is Petrotx - Limited Partnership (TLV:PTX) Using Too Much Debt?

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.' 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. As with many other companies Petrotx - Limited Partnership (TLV:PTX) makes use of debt. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

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. If things get really bad, the lenders can take control of the business. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Petrotx - Limited Partnership

What Is Petrotx - Limited Partnership's Net Debt?

You can click the graphic below for the historical numbers, but it shows that Petrotx - Limited Partnership had US$9.77m of debt in June 2022, down from US$11.2m, one year before. However, its balance sheet shows it holds US$13.2m in cash, so it actually has US$3.41m net cash.

How Healthy Is Petrotx - Limited Partnership's Balance Sheet?

The latest balance sheet data shows that Petrotx - Limited Partnership had liabilities of US$8.76m due within a year, and liabilities of US$13.3m falling due after that. On the other hand, it had cash of US$13.2m and US$2.26m worth of receivables due within a year. So its liabilities total US$6.65m more than the combination of its cash and short-term receivables.

This is a mountain of leverage relative to its market capitalization of US$7.21m. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution. While it does have liabilities worth noting, Petrotx - Limited Partnership also has more cash than debt, so we're pretty confident it can manage its debt safely.

Better yet, Petrotx - Limited Partnership grew its EBIT by 113% last year, which is an impressive improvement. That boost will make it even easier to pay down debt going forward. When analysing debt levels, the balance sheet is the obvious place to start. But it is Petrotx - 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.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. Petrotx - Limited Partnership may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Looking at the most recent two years, Petrotx - Limited Partnership recorded free cash flow of 32% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing Up

Although Petrotx - Limited Partnership'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$3.41m. And we liked the look of last year's 113% year-on-year EBIT growth. So we are not troubled with Petrotx - Limited Partnership's debt use. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for Petrotx - Limited Partnership (of which 1 is a bit concerning!) you should know about.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.