Is Diamond Offshore Drilling (NYSE:DO) Using Too Much Debt?

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. As with many other companies Diamond Offshore Drilling, Inc. (NYSE:DO) makes use of debt. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Diamond Offshore Drilling

What Is Diamond Offshore Drilling's Net Debt?

The image below, which you can click on for greater detail, shows that at September 2023 Diamond Offshore Drilling had debt of US$535.2m, up from US$335.5m in one year. On the flip side, it has US$146.8m in cash leading to net debt of about US$388.4m.

A Look At Diamond Offshore Drilling's Liabilities

We can see from the most recent balance sheet that Diamond Offshore Drilling had liabilities of US$261.5m falling due within a year, and liabilities of US$757.2m due beyond that. On the other hand, it had cash of US$146.8m and US$225.4m worth of receivables due within a year. So its liabilities total US$646.4m more than the combination of its cash and short-term receivables.

While this might seem like a lot, it is not so bad since Diamond Offshore Drilling has a market capitalization of US$1.24b, 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. 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 Diamond Offshore Drilling's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Over 12 months, Diamond Offshore Drilling reported revenue of US$912m, which is a gain of 30%, although it did not report any earnings before interest and tax. With any luck the company will be able to grow its way to profitability.

Caveat Emptor

Despite the top line growth, Diamond Offshore Drilling still had an earnings before interest and tax (EBIT) loss over the last year. Indeed, it lost US$10m at the EBIT level. When we look at that and recall the liabilities on its balance sheet, relative to cash, it seems unwise to us for the company to have any debt. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. However, it doesn't help that it burned through US$66m of cash over the last year. So in short it's a really risky stock. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should be aware of the 1 warning sign we've spotted with Diamond Offshore Drilling .

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.