Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We can see that The New Zealand Refining Company Limited (NZSE:NZR) does use debt in its business. But should shareholders be worried about its use of debt?
When Is Debt Dangerous?
Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. If things get really bad, the lenders can take control of the business. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
How Much Debt Does New Zealand Refining Carry?
As you can see below, at the end of December 2020, New Zealand Refining had NZ$274.6m of debt, up from NZ$250.2m a year ago. Click the image for more detail. However, because it has a cash reserve of NZ$43.3m, its net debt is less, at about NZ$231.3m.
How Strong Is New Zealand Refining's Balance Sheet?
We can see from the most recent balance sheet that New Zealand Refining had liabilities of NZ$174.9m falling due within a year, and liabilities of NZ$429.8m due beyond that. Offsetting this, it had NZ$43.3m in cash and NZ$24.8m in receivables that were due within 12 months. So it has liabilities totalling NZ$536.6m more than its cash and near-term receivables, combined.
This deficit casts a shadow over the NZ$145.3m company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. At the end of the day, New Zealand Refining would probably need a major re-capitalization if its creditors were to demand repayment. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if New Zealand Refining 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.
Over 12 months, New Zealand Refining made a loss at the EBIT level, and saw its revenue drop to NZ$234m, which is a fall of 32%. That makes us nervous, to say the least.
While New Zealand Refining's falling revenue is about as heartwarming as a wet blanket, arguably its earnings before interest and tax (EBIT) loss is even less appealing. Its EBIT loss was a whopping NZ$49m. If you consider the significant liabilities mentioned above, we are extremely wary of this investment. Of course, it may be able to improve its situation with a bit of luck and good execution. But we think that is unlikely since it is low on liquid assets, and made a loss of NZ$198m in the last year. So we think this stock is quite risky. We'd prefer to pass. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. We've identified 1 warning sign with New Zealand Refining , and understanding them should be part of your investment process.
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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