We Think Magnolia Oil & Gas (NYSE:MGY) Can Manage Its Debt With Ease

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. We note that Magnolia Oil & Gas Corporation (NYSE:MGY) does have debt on its balance sheet. 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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

See 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$389.2m in debt in June 2022; about the same as the year before. But on the other hand it also has US$501.9m in cash, leading to a US$112.7m net cash position.

A Look At Magnolia Oil & Gas' Liabilities

Zooming in on the latest balance sheet data, we can see that Magnolia Oil & Gas had liabilities of US$333.0m due within 12 months and liabilities of US$485.2m due beyond that. On the other hand, it had cash of US$501.9m and US$179.7m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$136.7m.

Of course, Magnolia Oil & Gas has a market capitalization of US$5.10b, 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.

Even more impressive was the fact that Magnolia Oil & Gas grew its EBIT by 223% over twelve months. If maintained that growth will make the debt even more manageable in the years ahead. 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 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 two years, Magnolia Oil & Gas generated free cash flow amounting to a very robust 85% 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$112.7m. And it impressed us with free cash flow of US$751m, being 85% of its EBIT. So we don't think Magnolia Oil & Gas's use of debt is risky. 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. For instance, we've identified 2 warning signs for Magnolia Oil & Gas (1 doesn't sit too well with us) you should be aware of.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.