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 seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We note that Marathon Oil Corporation (NYSE:MRO) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.
When Is Debt Dangerous?
Debt assists a business until the business has trouble paying it off, either with new capital or with free 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, 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
How Much Debt Does Marathon Oil Carry?
The image below, which you can click on for greater detail, shows that at September 2020 Marathon Oil had debt of US$5.93b, up from US$5.50b in one year. However, it does have US$1.12b in cash offsetting this, leading to net debt of about US$4.81b.
How Healthy Is Marathon Oil's Balance Sheet?
According to the last reported balance sheet, Marathon Oil had liabilities of US$1.57b due within 12 months, and liabilities of US$6.21b due beyond 12 months. On the other hand, it had cash of US$1.12b and US$643.0m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$6.01b.
This deficit is considerable relative to its market capitalization of US$6.51b, so it does suggest shareholders should keep an eye on Marathon Oil's use of debt. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Marathon Oil'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.
In the last year Marathon Oil had a loss before interest and tax, and actually shrunk its revenue by 33%, to US$3.5b. That makes us nervous, to say the least.
While Marathon Oil's falling revenue is about as heartwarming as a wet blanket, arguably its earnings before interest and tax (EBIT) loss is even less appealing. Indeed, it lost US$604m at the EBIT level. When we look at that and recall the liabilities on its balance sheet, relative to cash, it seems unwise to us for the company to have any debt. So we think its balance sheet is a little strained, though not beyond repair. We would feel better if it turned its trailing twelve month loss of US$1.1b into a profit. So to be blunt we do think it 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. Take risks, for example - Marathon Oil has 2 warning signs (and 1 which is significant) we think you should know about.
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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