These 4 Measures Indicate That Magnolia Oil & Gas (NYSE:MGY) Is Using Debt Safely

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.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We can see that Magnolia Oil & Gas Corporation (NYSE:MGY) does use debt in its business. But is this debt a concern to shareholders?

When Is Debt A Problem?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. 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.

View our latest analysis for Magnolia Oil & Gas

What Is Magnolia Oil & Gas's Net Debt?

The chart below, which you can click on for greater detail, shows that Magnolia Oil & Gas had US$390.4m in debt in December 2022; about the same as the year before. However, it does have US$675.4m in cash offsetting this, leading to net cash of US$285.1m.

How Healthy Is Magnolia Oil & Gas' Balance Sheet?

We can see from the most recent balance sheet that Magnolia Oil & Gas had liabilities of US$340.3m falling due within a year, and liabilities of US$492.1m due beyond that. Offsetting this, it had US$675.4m in cash and US$170.8m in receivables that were due within 12 months. So these liquid assets roughly match the total liabilities.

This state of affairs indicates that Magnolia Oil & Gas' balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So it's very unlikely that the US$4.91b company is short on cash, but still worth keeping an eye on the 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.

In addition to that, we're happy to report that Magnolia Oil & Gas has boosted its EBIT by 79%, thus reducing the spectre of future debt repayments. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Magnolia Oil & Gas'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.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Magnolia Oil & Gas may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. During the last three years, Magnolia Oil & Gas generated free cash flow amounting to a very robust 88% 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$285.1m in net cash and a decent-looking balance sheet. The cherry on top was that in converted 88% of that EBIT to free cash flow, bringing in US$832m. So is Magnolia Oil & Gas'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. Be aware that Magnolia Oil & Gas is showing 2 warning signs in our investment analysis , and 1 of those makes us a bit uncomfortable...

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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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.