We Think Ranger Oil (NASDAQ:ROCC) Can Stay On Top Of Its Debt

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. Importantly, Ranger Oil Corporation (NASDAQ:ROCC) does carry debt. But the real question is whether this debt is making the company risky.

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Ranger Oil

What Is Ranger Oil's Debt?

You can click the graphic below for the historical numbers, but it shows that as of June 2022 Ranger Oil had US$567.2m of debt, an increase on US$382.9m, over one year. On the flip side, it has US$34.5m in cash leading to net debt of about US$532.8m.

A Look At Ranger Oil's Liabilities

The latest balance sheet data shows that Ranger Oil had liabilities of US$445.7m due within a year, and liabilities of US$606.7m falling due after that. On the other hand, it had cash of US$34.5m and US$200.3m worth of receivables due within a year. So its liabilities total US$817.7m more than the combination of its cash and short-term receivables.

While this might seem like a lot, it is not so bad since Ranger Oil has a market capitalization of US$1.71b, and so it could probably strengthen its balance sheet by raising capital if it needed to. However, it is still worthwhile taking a close look at its ability to pay off debt.

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.

While Ranger Oil's low debt to EBITDA ratio of 1.1 suggests only modest use of debt, the fact that EBIT only covered the interest expense by 7.0 times last year does give us pause. But the interest payments are certainly sufficient to have us thinking about how affordable its debt is. Better yet, Ranger Oil grew its EBIT by 11,745% last year, which is an impressive improvement. That boost will make it even easier to pay down debt going forward. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Ranger Oil's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So it's worth checking how much of that EBIT is backed by free cash flow. In the last three years, Ranger Oil'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

When it comes to the balance sheet, the standout positive for Ranger Oil was the fact that it seems able to grow its EBIT confidently. However, our other observations weren't so heartening. For instance it seems like it has to struggle a bit to convert EBIT to free cash flow. When we consider all the elements mentioned above, it seems to us that Ranger Oil is managing its debt quite well. But a word of caution: we think debt levels are high enough to justify ongoing monitoring. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. For example Ranger Oil has 2 warning signs (and 1 which is a bit concerning) we think 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.