Warren Buffett famously said, 'Volatility is far from synonymous with risk.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We can see that Petrolia SE (OB:PSE) does use debt in its business. But is this debt a concern to shareholders?
What Risk Does Debt Bring?
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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.
View our latest analysis for Petrolia
How Much Debt Does Petrolia Carry?
As you can see below, Petrolia had US$4.69m of debt, at December 2020, which is about the same as the year before. You can click the chart for greater detail. But on the other hand it also has US$16.0m in cash, leading to a US$11.4m net cash position.
How Healthy Is Petrolia's Balance Sheet?
We can see from the most recent balance sheet that Petrolia had liabilities of US$15.1m falling due within a year, and liabilities of US$15.1m due beyond that. On the other hand, it had cash of US$16.0m and US$10.3m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$3.90m.
Given Petrolia has a market capitalization of US$77.1m, it's hard to believe these liabilities pose much threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. While it does have liabilities worth noting, Petrolia also has more cash than debt, so we're pretty confident it can manage its debt safely.
Shareholders should be aware that Petrolia's EBIT was down 89% last year. If that earnings trend continues then paying off its debt will be about as easy as herding cats on to a roller coaster. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Petrolia will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Petrolia has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Over the last three years, Petrolia actually produced more free cash flow than EBIT. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.
Summing up
While it is always sensible to look at a company's total liabilities, it is very reassuring that Petrolia has US$11.4m in net cash. And it impressed us with free cash flow of US$15m, being 162% of its EBIT. So we don't have any problem with Petrolia's use of debt. 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 2 warning signs for Petrolia you should know about.
If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.
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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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About OB:PSE
Petrolia
Sells and rents energy service equipment to energy industry in Norway, rest of Europe, Asia, and Australia.
Flawless balance sheet with solid track record.
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