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 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. We can see that Callon Petroleum Company (NYSE:CPE) does use debt in its business. But should shareholders be worried about its use of debt?
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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.
What Is Callon Petroleum's Net Debt?
The image below, which you can click on for greater detail, shows that Callon Petroleum had debt of US$2.90b at the end of March 2021, a reduction from US$3.25b over a year. And it doesn't have much cash, so its net debt is about the same.
How Healthy Is Callon Petroleum's Balance Sheet?
The latest balance sheet data shows that Callon Petroleum had liabilities of US$672.0m due within a year, and liabilities of US$3.04b falling due after that. On the other hand, it had cash of US$24.4m and US$179.1m worth of receivables due within a year. So its liabilities total US$3.51b more than the combination of its cash and short-term receivables.
This deficit casts a shadow over the US$1.78b company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. After all, Callon Petroleum would likely require a major re-capitalisation if it had to pay its creditors today. 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 Callon Petroleum 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.
In the last year Callon Petroleum wasn't profitable at an EBIT level, but managed to grow its revenue by 36%, to US$1.1b. Shareholders probably have their fingers crossed that it can grow its way to profits.
While we can certainly appreciate Callon Petroleum's revenue growth, its earnings before interest and tax (EBIT) loss is not ideal. Indeed, it lost a very considerable US$286m at the EBIT level. When we look at that alongside the significant liabilities, we're not particularly confident about the company. We'd want to see some strong near-term improvements before getting too interested in the stock. Not least because it burned through US$49m in negative free cash flow over the last year. So suffice it to say we consider the stock to be risky. 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. Case in point: We've spotted 3 warning signs for Callon Petroleum you should be aware of.
When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.
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Callon Petroleum Company, an independent oil and natural gas company, focuses on the acquisition, exploration, and development of oil and natural gas properties in Permian Basin in West Texas.
Undervalued with acceptable track record.