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 might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We can see that Occidental Petroleum Corporation (NYSE:OXY) does use debt in its business. 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. 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.
How Much Debt Does Occidental Petroleum Carry?
You can click the graphic below for the historical numbers, but it shows that Occidental Petroleum had US$40.0b of debt in September 2020, down from US$49.4b, one year before. However, it also had US$1.90b in cash, and so its net debt is US$38.1b.
How Strong Is Occidental Petroleum's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Occidental Petroleum had liabilities of US$10.5b due within 12 months and liabilities of US$54.1b due beyond that. Offsetting this, it had US$1.90b in cash and US$2.08b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$60.6b.
The deficiency here weighs heavily on the US$18.7b 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'd watch its balance sheet closely, without a doubt. At the end of the day, Occidental Petroleum would probably need a major re-capitalization if its creditors were to demand repayment. 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 Occidental Petroleum 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.
In the last year Occidental Petroleum wasn't profitable at an EBIT level, but managed to grow its revenue by 3.7%, to US$20b. That rate of growth is a bit slow for our taste, but it takes all types to make a world.
Over the last twelve months Occidental Petroleum produced an earnings before interest and tax (EBIT) loss. Its EBIT loss was a whopping US$7.7b. 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. But we think that is unlikely since it is low on liquid assets, and made a loss of US$14b in the last year. So we think this stock is quite risky. We'd prefer to pass. 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. Be aware that Occidental Petroleum is showing 2 warning signs in our investment analysis , you should know about...
When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.
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