These 4 Measures Indicate That Aker BP (OB:AKRBP) Is Using Debt Reasonably Well

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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 Aker BP ASA (OB:AKRBP) makes use of debt. But the real question is whether this debt is making the company risky.

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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 thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for Aker BP

What Is Aker BP's Net Debt?

The image below, which you can click on for greater detail, shows that at December 2022 Aker BP had debt of US$5.28b, up from US$3.58b in one year. However, because it has a cash reserve of US$2.76b, its net debt is less, at about US$2.52b.

A Look At Aker BP's Liabilities

We can see from the most recent balance sheet that Aker BP had liabilities of US$6.25b falling due within a year, and liabilities of US$18.9b due beyond that. On the other hand, it had cash of US$2.76b and US$1.51b worth of receivables due within a year. So it has liabilities totalling US$20.9b more than its cash and near-term receivables, combined.

Given this deficit is actually higher than the company's massive market capitalization of US$16.8b, we think shareholders really should watch Aker BP's debt levels, like a parent watching their child ride a bike for the first time. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price.

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.

Aker BP has a low net debt to EBITDA ratio of only 0.21. And its EBIT covers its interest expense a whopping 121 times over. So we're pretty relaxed about its super-conservative use of debt. Better yet, Aker BP grew its EBIT by 204% last year, which is an impressive improvement. If maintained that growth will make the debt even more manageable in the years ahead. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Aker BP can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

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, Aker BP produced sturdy free cash flow equating to 53% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Our View

Both Aker BP's ability to to cover its interest expense with its EBIT and its EBIT growth rate gave us comfort that it can handle its debt. But truth be told its level of total liabilities had us nibbling our nails. When we consider all the elements mentioned above, it seems to us that Aker BP is managing its debt quite well. Having said that, the load is sufficiently heavy that we would recommend any shareholders keep a close eye on it. 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. Case in point: We've spotted 3 warning signs for Aker BP you should be aware of, and 2 of them can't be ignored.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.