Does Panoro Energy (OB:PEN) Have A Healthy Balance Sheet?

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. Importantly, Panoro Energy ASA (OB:PEN) does carry debt. But should shareholders be worried about its use of debt?

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When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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 think about a company's use of debt, we first look at cash and debt together.

What Is Panoro Energy's Debt?

As you can see below, at the end of December 2024, Panoro Energy had US$145.9m of debt, up from US$69.5m a year ago. Click the image for more detail. However, it also had US$72.9m in cash, and so its net debt is US$73.1m.

A Look At Panoro Energy's Liabilities

According to the last reported balance sheet, Panoro Energy had liabilities of US$64.5m due within 12 months, and liabilities of US$380.5m due beyond 12 months. Offsetting this, it had US$72.9m in cash and US$37.2m in receivables that were due within 12 months. So its liabilities total US$335.0m more than the combination of its cash and short-term receivables.

Given this deficit is actually higher than the company's market capitalization of US$273.9m, we think shareholders really should watch Panoro Energy'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.

View our latest analysis for Panoro Energy

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). 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 Panoro Energy's low debt to EBITDA ratio of 0.48 suggests only modest use of debt, the fact that EBIT only covered the interest expense by 4.5 times last year does give us pause. But the interest payments are certainly sufficient to have us thinking about how affordable its debt is. One way Panoro Energy could vanquish its debt would be if it stops borrowing more but continues to grow EBIT at around 15%, as it did over the last year. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Panoro Energy's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. In the last three years, Panoro Energy's free cash flow amounted to 27% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Our View

Panoro Energy's level of total liabilities and conversion of EBIT to free cash flow definitely weigh on it, in our esteem. But its net debt to EBITDA tells a very different story, and suggests some resilience. When we consider all the factors discussed, it seems to us that Panoro Energy 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. These risks can be hard to spot. Every company has them, and we've spotted 1 warning sign for Panoro Energy 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. 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.