Health Check: How Prudently Does Independence Contract Drilling (NYSE:ICD) Use Debt?

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.' 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. Importantly, Independence Contract Drilling, Inc. (NYSE:ICD) does carry debt. But the more important question is: how much risk is that debt creating?

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 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. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Independence Contract Drilling

What Is Independence Contract Drilling's Net Debt?

The chart below, which you can click on for greater detail, shows that Independence Contract Drilling had US$135.0m in debt in September 2022; about the same as the year before. However, it also had US$7.57m in cash, and so its net debt is US$127.4m.

How Healthy Is Independence Contract Drilling's Balance Sheet?

The latest balance sheet data shows that Independence Contract Drilling had liabilities of US$45.4m due within a year, and liabilities of US$157.8m falling due after that. Offsetting this, it had US$7.57m in cash and US$34.0m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$161.7m.

This deficit casts a shadow over the US$47.7m company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. After all, Independence Contract Drilling would likely require a major re-capitalisation if it had to pay its creditors today. 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 Independence Contract Drilling'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.

In the last year Independence Contract Drilling wasn't profitable at an EBIT level, but managed to grow its revenue by 113%, to US$155m. So there's no doubt that shareholders are cheering for growth

Caveat Emptor

While we can certainly appreciate Independence Contract Drilling's revenue growth, its earnings before interest and tax (EBIT) loss is not ideal. Indeed, it lost a very considerable US$17m at the EBIT level. If you consider the significant liabilities mentioned above, we are extremely wary of this investment. Of course, it may be able to improve its situation with a bit of luck and good execution. Nevertheless, we would not bet on it given that it vaporized US$17m in cash over the last twelve months, and it doesn't have much by way of liquid assets. So we think this stock is risky, like walking through a dirty dog park with a mask on. 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. For instance, we've identified 3 warning signs for Independence Contract Drilling that you should be aware of.

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.