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. Importantly, Nine Energy Service, Inc. (NYSE:NINE) does carry debt. But is this debt a concern to shareholders?
What Risk Does Debt Bring?
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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. The first step when considering a company's debt levels is to consider its cash and debt together.
What Is Nine Energy Service's Net Debt?
The image below, which you can click on for greater detail, shows that Nine Energy Service had debt of US$343.9m at the end of September 2020, a reduction from US$391.5m over a year. However, because it has a cash reserve of US$80.3m, its net debt is less, at about US$263.5m.
A Look At Nine Energy Service's Liabilities
Zooming in on the latest balance sheet data, we can see that Nine Energy Service had liabilities of US$35.2m due within 12 months and liabilities of US$349.7m due beyond that. Offsetting this, it had US$80.3m in cash and US$36.1m in receivables that were due within 12 months. So its liabilities total US$268.5m more than the combination of its cash and short-term receivables.
The deficiency here weighs heavily on the US$84.9m company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we definitely think shareholders need to watch this one closely. After all, Nine Energy Service would likely require a major re-capitalisation if it had to pay its creditors today. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Nine Energy Service 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.
In the last year Nine Energy Service had a loss before interest and tax, and actually shrunk its revenue by 54%, to US$412m. To be frank that doesn't bode well.
Not only did Nine Energy Service's revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). Indeed, it lost a very considerable US$67m at the EBIT level. If you consider the significant liabilities mentioned above, we are extremely wary of this investment. That said, it is possible that the company will turn its fortunes around. Nevertheless, we would not bet on it given that it vaporized US$4.0m in cash over the last twelve months, and it doesn't have much by way of liquid assets. So we consider this a high risk stock and we wouldn't be at all surprised if the company asks shareholders for money before long. 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 - Nine Energy Service has 4 warning signs we think 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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