Does Civeo (NYSE:CVEO) Have A Healthy Balance Sheet?

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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. Importantly, Civeo Corporation (NYSE:CVEO) does carry debt. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

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. If things get really bad, the lenders can take control of the business. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Civeo

What Is Civeo's Net Debt?

As you can see below, Civeo had US$141.9m of debt at March 2023, down from US$175.9m a year prior. On the flip side, it has US$12.4m in cash leading to net debt of about US$129.6m.

How Strong Is Civeo's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Civeo had liabilities of US$103.2m due within 12 months and liabilities of US$155.8m due beyond that. Offsetting these obligations, it had cash of US$12.4m as well as receivables valued at US$123.0m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$123.7m.

While this might seem like a lot, it is not so bad since Civeo has a market capitalization of US$287.4m, and so it could probably strengthen its balance sheet by raising capital if it needed to. But it's clear that we should definitely closely examine whether it can manage its debt without dilution.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Civeo has a very low debt to EBITDA ratio of 1.3 so it is strange to see weak interest coverage, with last year's EBIT being only 1.2 times the interest expense. So one way or the other, it's clear the debt levels are not trivial. Shareholders should be aware that Civeo's EBIT was down 48% last year. If that decline continues then paying off debt will be harder than selling foie gras at a vegan convention. 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 Civeo 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 company can only pay off debt with cold hard cash, not accounting profits. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the last two years, Civeo 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.

Our View

Civeo's EBIT growth rate and interest cover definitely weigh on it, in our esteem. But its conversion of EBIT to free cash flow tells a very different story, and suggests some resilience. Taking the abovementioned factors together we do think Civeo's debt poses some risks to the business. So while that leverage does boost returns on equity, we wouldn't really want to see it increase from here. When analysing debt levels, the balance sheet is the obvious place to start. 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 2 warning signs for Civeo 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. 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.