Is Magnolia Oil & Gas (NYSE:MGY) A Risky Investment?

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.' 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. Importantly, Magnolia Oil & Gas Corporation (NYSE:MGY) does carry debt. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. If things get really bad, the lenders can take control of the business. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Magnolia Oil & Gas

How Much Debt Does Magnolia Oil & Gas Carry?

The chart below, which you can click on for greater detail, shows that Magnolia Oil & Gas had US$391.6m in debt in June 2023; about the same as the year before. But on the other hand it also has US$676.6m in cash, leading to a US$285.0m net cash position.

How Strong Is Magnolia Oil & Gas' Balance Sheet?

We can see from the most recent balance sheet that Magnolia Oil & Gas had liabilities of US$263.0m falling due within a year, and liabilities of US$493.9m due beyond that. On the other hand, it had cash of US$676.6m and US$137.4m worth of receivables due within a year. So it can boast US$57.1m more liquid assets than total liabilities.

Having regard to Magnolia Oil & Gas' size, it seems that its liquid assets are well balanced with its total liabilities. So while it's hard to imagine that the US$4.79b company is struggling for cash, we still think it's worth monitoring its balance sheet. Simply put, the fact that Magnolia Oil & Gas has more cash than debt is arguably a good indication that it can manage its debt safely.

But the bad news is that Magnolia Oil & Gas has seen its EBIT plunge 19% in the last twelve months. We think hat kind of performance, if repeated frequently, could well lead to difficulties for the stock. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Magnolia Oil & Gas can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Magnolia Oil & Gas 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. During the last three years, Magnolia Oil & Gas generated free cash flow amounting to a very robust 83% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.

Summing Up

While it is always sensible to investigate a company's debt, in this case Magnolia Oil & Gas has US$285.0m in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of US$617m, being 83% of its EBIT. So we don't have any problem with Magnolia Oil & Gas's use of debt. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. Be aware that Magnolia Oil & Gas is showing 2 warning signs in our investment analysis , and 1 of those shouldn't be ignored...

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.