Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. As with many other companies Odfjell Drilling Ltd. (OB:ODL) makes use of debt. But the real question is whether this debt is making the company risky.
What Risk Does Debt Bring?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.
Check out our latest analysis for Odfjell Drilling
What Is Odfjell Drilling's Net Debt?
You can click the graphic below for the historical numbers, but it shows that Odfjell Drilling had US$654.8m of debt in June 2024, down from US$762.6m, one year before. However, because it has a cash reserve of US$111.1m, its net debt is less, at about US$543.7m.
How Strong Is Odfjell Drilling's Balance Sheet?
According to the last reported balance sheet, Odfjell Drilling had liabilities of US$227.8m due within 12 months, and liabilities of US$592.9m due beyond 12 months. Offsetting this, it had US$111.1m in cash and US$103.5m in receivables that were due within 12 months. So its liabilities total US$606.1m more than the combination of its cash and short-term receivables.
This deficit isn't so bad because Odfjell Drilling is worth US$1.13b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution.
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). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).
While Odfjell Drilling has a quite reasonable net debt to EBITDA multiple of 1.8, its interest cover seems weak, at 2.2. This does have us wondering if the company pays high interest because it is considered risky. In any case, it's safe to say the company has meaningful debt. One way Odfjell Drilling could vanquish its debt would be if it stops borrowing more but continues to grow EBIT at around 11%, as it did over the last year. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Odfjell Drilling 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 the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Happily for any shareholders, Odfjell Drilling actually produced more free cash flow than EBIT over the last three years. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.
Our View
On our analysis Odfjell Drilling's conversion of EBIT to free cash flow should signal that it won't have too much trouble with its debt. However, our other observations weren't so heartening. To be specific, it seems about as good at covering its interest expense with its EBIT as wet socks are at keeping your feet warm. Considering this range of data points, we think Odfjell Drilling is in a good position to manage its debt levels. Having said that, the load is sufficiently heavy that we would recommend any shareholders keep a close eye on it. 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. To that end, you should be aware of the 1 warning sign we've spotted with Odfjell Drilling .
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.
New: AI Stock Screener & Alerts
Our new AI Stock Screener scans the market every day to uncover opportunities.
• Dividend Powerhouses (3%+ Yield)
• Undervalued Small Caps with Insider Buying
• High growth Tech and AI Companies
Or build your own from over 50 metrics.
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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.
About OB:ODL
Odfjell Drilling
Owns and operates mobile offshore drilling units primarily in Norway and Namibia.
Very undervalued established dividend payer.