These 4 Measures Indicate That Murphy Oil (NYSE:MUR) Is Using Debt Extensively

By
Simply Wall St
Published
November 06, 2021
NYSE:MUR
Source: Shutterstock

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.' 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. As with many other companies Murphy Oil Corporation (NYSE:MUR) makes use of debt. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Murphy Oil

How Much Debt Does Murphy Oil Carry?

As you can see below, Murphy Oil had US$2.61b of debt at September 2021, down from US$2.99b a year prior. However, because it has a cash reserve of US$505.1m, its net debt is less, at about US$2.11b.

debt-equity-history-analysis
NYSE:MUR Debt to Equity History November 7th 2021

How Healthy Is Murphy Oil's Balance Sheet?

According to the last reported balance sheet, Murphy Oil had liabilities of US$1.13b due within 12 months, and liabilities of US$5.08b due beyond 12 months. Offsetting this, it had US$505.1m in cash and US$186.7m in receivables that were due within 12 months. So it has liabilities totalling US$5.53b more than its cash and near-term receivables, combined.

Given this deficit is actually higher than the company's market capitalization of US$4.45b, we think shareholders really should watch Murphy Oil's debt levels, like a parent watching their child ride a bike for the first time. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

While Murphy Oil has a quite reasonable net debt to EBITDA multiple of 2.3, its interest cover seems weak, at 0.061. In large part that's it has so much depreciation and amortisation. While companies often boast that these charges are non-cash, most such businesses will therefore require ongoing investment (that is not expensed.) In any case, it's safe to say the company has meaningful debt. Notably, Murphy Oil made a loss at the EBIT level, last year, but improved that to positive EBIT of US$14m in the last twelve months. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Murphy Oil's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it's worth checking how much of the earnings before interest and tax (EBIT) is backed by free cash flow. Over the last year, Murphy Oil actually produced more free cash flow than EBIT. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Our View

Neither Murphy Oil's ability to cover its interest expense with its EBIT nor its level of total liabilities gave us confidence in its ability to take on more debt. But the good news is it seems to be able to convert EBIT to free cash flow with ease. When we consider all the factors discussed, it seems to us that Murphy Oil is taking some risks with its use of debt. So while that leverage does boost returns on equity, we wouldn't really want to see it increase from here. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. We've identified 2 warning signs with Murphy Oil , and understanding them should be part of your investment process.

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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