Is Confidence Petroleum India (NSE:CONFIPET) A Risky Investment?

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. We note that Confidence Petroleum India Limited (NSE:CONFIPET) does have debt on its balance sheet. But is this debt a concern to shareholders?

When Is Debt A Problem?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. 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, 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.

Check out our latest analysis for Confidence Petroleum India

How Much Debt Does Confidence Petroleum India Carry?

You can click the graphic below for the historical numbers, but it shows that as of March 2021 Confidence Petroleum India had ₹875.1m of debt, an increase on ₹728.3m, over one year. On the flip side, it has ₹657.5m in cash leading to net debt of about ₹217.6m.

How Strong Is Confidence Petroleum India's Balance Sheet?

The latest balance sheet data shows that Confidence Petroleum India had liabilities of ₹556.6m due within a year, and liabilities of ₹1.79b falling due after that. On the other hand, it had cash of ₹657.5m and ₹856.1m worth of receivables due within a year. So its liabilities total ₹832.8m more than the combination of its cash and short-term receivables.

Given Confidence Petroleum India has a market capitalization of ₹22.6b, it's hard to believe these liabilities pose much threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. But either way, Confidence Petroleum India has virtually no net debt, so it's fair to say it does not have a heavy debt load!

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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Confidence Petroleum India has a low net debt to EBITDA ratio of only 0.14. And its EBIT easily covers its interest expense, being 12.8 times the size. So you could argue it is no more threatened by its debt than an elephant is by a mouse. Better yet, Confidence Petroleum India grew its EBIT by 124% 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 you can't view debt in total isolation; since Confidence Petroleum India 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 we always check how much of that EBIT is translated into free cash flow. During the last three years, Confidence Petroleum India 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

Happily, Confidence Petroleum India's impressive interest cover implies it has the upper hand on its debt. But the stark truth is that we are concerned by its conversion of EBIT to free cash flow. Taking all this data into account, it seems to us that Confidence Petroleum India takes a pretty sensible approach to debt. While that brings some risk, it can also enhance returns for shareholders. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. Be aware that Confidence Petroleum India is showing 2 warning signs in our investment analysis , 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.
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