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

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.' 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 can see that Magnolia Oil & Gas Corporation (NYSE:MGY) does use debt in its business. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

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 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. 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

What Is Magnolia Oil & Gas's Net Debt?

As you can see below, Magnolia Oil & Gas had US$392.8m of debt, at December 2023, which is about the same as the year before. You can click the chart for greater detail. However, its balance sheet shows it holds US$401.1m in cash, so it actually has US$8.28m net cash.

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$314.9m falling due within a year, and liabilities of US$558.7m due beyond that. On the other hand, it had cash of US$401.1m and US$189.7m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$282.7m.

Of course, Magnolia Oil & Gas has a market capitalization of US$5.25b, so these liabilities are probably manageable. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. While it does have liabilities worth noting, Magnolia Oil & Gas also has more cash than debt, so we're pretty confident it can manage its debt safely.

It is just as well that Magnolia Oil & Gas's load is not too heavy, because its EBIT was down 50% over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Magnolia Oil & Gas 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.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. 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 82% of its EBIT, more than we'd expect. That positions it well to pay down debt if desirable to do so.

Summing Up

We could understand if investors are concerned about Magnolia Oil & Gas's liabilities, but we can be reassured by the fact it has has net cash of US$8.28m. The cherry on top was that in converted 82% of that EBIT to free cash flow, bringing in US$431m. So we don't have any problem with Magnolia Oil & Gas's use of debt. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. We've identified 2 warning signs with Magnolia Oil & Gas , 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.