These 4 Measures Indicate That Confidence Petroleum India (NSE:CONFIPET) Is Using Debt Extensively

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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. As with many other companies Confidence Petroleum India Limited (NSE:CONFIPET) makes use of debt. 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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, 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. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Confidence Petroleum India

What Is Confidence Petroleum India's Debt?

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. However, it also had ₹657.5m in cash, and so its net debt is ₹217.6m.

How Healthy Is Confidence Petroleum India's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Confidence Petroleum India had liabilities of ₹556.7m due within 12 months and liabilities of ₹1.79b due beyond that. Offsetting this, it had ₹657.5m in cash and ₹661.5m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₹1.03b.

Since publicly traded Confidence Petroleum India shares are worth a total of ₹16.9b, it seems unlikely that this level of liabilities would be a major threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. 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!

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (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 net debt of just 0.18 times EBITDA, indicating that it is certainly not a reckless borrower. And it boasts interest cover of 8.0 times, which is more than adequate. On the other hand, Confidence Petroleum India saw its EBIT drop by 10.0% in the last twelve months. That sort of decline, if sustained, will obviously make debt harder to handle. When analysing debt levels, the balance sheet is the obvious place to start. But it is Confidence Petroleum India's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the last three years, Confidence Petroleum India saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

Confidence Petroleum India's conversion of EBIT to free cash flow was a real negative on this analysis, although the other factors we considered cast it in a significantly better light. For example its net debt to EBITDA was refreshing. Looking at all the angles mentioned above, it does seem to us that Confidence Petroleum India is a somewhat risky investment as a result of its debt. Not all risk is bad, as it can boost share price returns if it pays off, but this debt risk is worth keeping in mind. The balance sheet is clearly the area to focus on when you are analysing debt. 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 1 warning sign for Confidence Petroleum India you should know about.

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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