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.' 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. Importantly, Murphy Oil Corporation (NYSE:MUR) does carry debt. 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 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.
What Is Murphy Oil's Debt?
The image below, which you can click on for greater detail, shows that Murphy Oil had debt of US$1.27b at the end of December 2024, a reduction from US$1.32b over a year. On the flip side, it has US$423.6m in cash leading to net debt of about US$846.9m.
How Healthy Is Murphy Oil's Balance Sheet?
According to the last reported balance sheet, Murphy Oil had liabilities of US$942.8m due within 12 months, and liabilities of US$3.38b due beyond 12 months. Offsetting these obligations, it had cash of US$423.6m as well as receivables valued at US$272.5m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$3.63b.
This is a mountain of leverage relative to its market capitalization of US$4.16b. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.
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In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).
Looking at its net debt to EBITDA of 0.53 and interest cover of 6.9 times, it seems to us that Murphy Oil is probably using debt in a pretty reasonable way. So we'd recommend keeping a close eye on the impact financing costs are having on the business. In fact Murphy Oil's saving grace is its low debt levels, because its EBIT has tanked 43% in the last twelve months. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. 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 Murphy Oil 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, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. During the last three years, Murphy Oil produced sturdy free cash flow equating to 77% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.
Our View
Murphy Oil's struggle to grow its EBIT had us second guessing its balance sheet strength, but the other data-points we considered were relatively redeeming. For example its conversion of EBIT to free cash flow was refreshing. Looking at all the angles mentioned above, it does seem to us that Murphy Oil is a somewhat risky investment as a result of its debt. That's not necessarily a bad thing, since leverage can boost returns on equity, but it is something to be aware of. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 1 warning sign for Murphy Oil you should be aware of.
At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.
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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.