Stock Analysis

Is Oil and Natural Gas (NSE:ONGC) A Risky Investment?

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NSEI:ONGC
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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.' 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 Oil and Natural Gas Corporation Limited (NSE:ONGC) makes use of debt. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, 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 Oil and Natural Gas

How Much Debt Does Oil and Natural Gas Carry?

As you can see below, at the end of March 2021, Oil and Natural Gas had ₹1.24t of debt, up from ₹1.17t a year ago. Click the image for more detail. However, it does have ₹191.7b in cash offsetting this, leading to net debt of about ₹1.05t.

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NSEI:ONGC Debt to Equity History August 27th 2021

How Healthy Is Oil and Natural Gas' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Oil and Natural Gas had liabilities of ₹1.23t due within 12 months and liabilities of ₹1.77t due beyond that. Offsetting these obligations, it had cash of ₹191.7b as well as receivables valued at ₹169.6b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₹2.65t.

The deficiency here weighs heavily on the ₹1.45t company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we definitely think shareholders need to watch this one closely. After all, Oil and Natural Gas would likely require a major re-capitalisation if it had to pay its creditors today.

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

Oil and Natural Gas's net debt is sitting at a very reasonable 1.7 times its EBITDA, while its EBIT covered its interest expense just 6.3 times last year. It seems that the business incurs large depreciation and amortisation charges, so maybe its debt load is heavier than it would first appear, since EBITDA is arguably a generous measure of earnings. On top of that, Oil and Natural Gas grew its EBIT by 78% over the last twelve months, and that growth will make it easier to handle its debt. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Oil and Natural Gas can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

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. Looking at the most recent three years, Oil and Natural Gas recorded free cash flow of 36% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

Our View

Oil and Natural Gas's level of total liabilities and conversion of EBIT to free cash flow definitely weigh on it, in our esteem. But its EBIT growth rate tells a very different story, and suggests some resilience. When we consider all the factors discussed, it seems to us that Oil and Natural Gas is taking some risks with its use of debt. While that debt can boost returns, we think the company has enough leverage now. 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 2 warning signs for Oil and Natural Gas you should be aware of.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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