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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We note that EOG Resources, Inc. (NYSE:EOG) does have debt on its balance sheet. But should shareholders be worried about its use of debt?
What Risk Does Debt Bring?
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 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. When we think about a company's use of debt, we first look at cash and debt together.
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How Much Debt Does EOG Resources Carry?
You can click the graphic below for the historical numbers, but it shows that EOG Resources had US$3.81b of debt in June 2023, down from US$5.09b, one year before. But it also has US$4.76b in cash to offset that, meaning it has US$950.0m net cash.
How Strong Is EOG Resources' Balance Sheet?
We can see from the most recent balance sheet that EOG Resources had liabilities of US$3.73b falling due within a year, and liabilities of US$11.5b due beyond that. Offsetting this, it had US$4.76b in cash and US$2.26b in receivables that were due within 12 months. So it has liabilities totalling US$8.20b more than its cash and near-term receivables, combined.
Of course, EOG Resources has a titanic market capitalization of US$76.6b, so these liabilities are probably manageable. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. While it does have liabilities worth noting, EOG Resources also has more cash than debt, so we're pretty confident it can manage its debt safely.
In addition to that, we're happy to report that EOG Resources has boosted its EBIT by 49%, thus reducing the spectre of future debt repayments. 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 EOG Resources 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.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While EOG Resources has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Over the most recent three years, EOG Resources recorded free cash flow worth 68% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.
Summing Up
Although EOG Resources's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of US$950.0m. And it impressed us with its EBIT growth of 49% over the last year. So is EOG Resources's debt a risk? It doesn't seem so to us. 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. We've identified 2 warning signs with EOG Resources (at least 1 which shouldn't be ignored) , and understanding them should be part of your investment process.
If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.
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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.
About NYSE:EOG
EOG Resources
Explores for, develops, produces, and markets crude oil, natural gas liquids, and natural gas primarily in producing basins in the United States, the Republic of Trinidad and Tobago and internationally.
Excellent balance sheet, good value and pays a dividend.