Ovintiv (NYSE:OVV) Takes On Some Risk With Its Use Of Debt

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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 can see that Ovintiv Inc. (NYSE:OVV) does use debt in its business. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

What Is Ovintiv's Net Debt?

The image below, which you can click on for greater detail, shows that Ovintiv had debt of US$5.45b at the end of December 2024, a reduction from US$5.74b over a year. And it doesn't have much cash, so its net debt is about the same.

A Look At Ovintiv's Liabilities

We can see from the most recent balance sheet that Ovintiv had liabilities of US$2.68b falling due within a year, and liabilities of US$6.24b due beyond that. Offsetting these obligations, it had cash of US$84.0m as well as receivables valued at US$1.12b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$7.72b.

This deficit is considerable relative to its very significant market capitalization of US$10.8b, so it does suggest shareholders should keep an eye on Ovintiv's use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.

View our latest analysis for Ovintiv

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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

While Ovintiv's low debt to EBITDA ratio of 1.2 suggests only modest use of debt, the fact that EBIT only covered the interest expense by 5.1 times last year does give us pause. But the interest payments are certainly sufficient to have us thinking about how affordable its debt is. Importantly, Ovintiv's EBIT fell a jaw-dropping 28% in the last twelve months. If that decline continues then paying off debt will be harder than selling foie gras at a vegan convention. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Ovintiv'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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Looking at the most recent three years, Ovintiv recorded free cash flow of 47% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

Our View

We'd go so far as to say Ovintiv's EBIT growth rate was disappointing. But at least it's pretty decent at managing its debt, based on its EBITDA,; that's encouraging. Looking at the balance sheet and taking into account all these factors, we do believe that debt is making Ovintiv stock a bit risky. That's not necessarily a bad thing, but we'd generally feel more comfortable with less leverage. 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. To that end, you should be aware of the 4 warning signs we've spotted with Ovintiv .

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.