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. We can see that SandRidge Energy, Inc. (NYSE:SD) does use debt in its business. But the more important question is: how much risk is that debt creating?
What Risk Does Debt Bring?
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. If things get really bad, the lenders can take control of the business. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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.
View our latest analysis for SandRidge Energy
How Much Debt Does SandRidge Energy Carry?
You can click the graphic below for the historical numbers, but it shows that SandRidge Energy had US$20.0m of debt in June 2021, down from US$59.0m, one year before. However, its balance sheet shows it holds US$88.3m in cash, so it actually has US$68.3m net cash.
How Strong Is SandRidge Energy's Balance Sheet?
According to the last reported balance sheet, SandRidge Energy had liabilities of US$59.2m due within 12 months, and liabilities of US$57.6m due beyond 12 months. Offsetting these obligations, it had cash of US$88.3m as well as receivables valued at US$20.7m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$7.86m.
Given SandRidge Energy has a market capitalization of US$298.5m, it's hard to believe these liabilities pose much threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. Despite its noteworthy liabilities, SandRidge Energy boasts net cash, so it's fair to say it does not have a heavy debt load!
Although SandRidge Energy made a loss at the EBIT level, last year, it was also good to see that it generated US$40m in EBIT over the last twelve months. The balance sheet is clearly the area to focus on when you are analysing debt. But it is SandRidge Energy's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.
Finally, a company can only pay off debt with cold hard cash, not accounting profits. SandRidge Energy may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Happily for any shareholders, SandRidge Energy actually produced more free cash flow than EBIT over the last year. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.
Summing up
While it is always sensible to look at a company's total liabilities, it is very reassuring that SandRidge Energy has US$68.3m in net cash. And it impressed us with free cash flow of US$42m, being 105% of its EBIT. So is SandRidge Energy's debt a risk? It doesn't seem so to us. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. For instance, we've identified 3 warning signs for SandRidge Energy that 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.
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About NYSE:SD
SandRidge Energy
Engages in the acquisition, development, and production of oil, natural gas, and natural gas liquids in the United States Mid-Continent.
Flawless balance sheet low.
