Does Scorpio Tankers (NYSE:STNG) Have A Healthy Balance Sheet?

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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 note that Scorpio Tankers Inc. (NYSE:STNG) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. 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 thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for Scorpio Tankers

What Is Scorpio Tankers's Net Debt?

You can click the graphic below for the historical numbers, but it shows that Scorpio Tankers had US$543.3m of debt in June 2022, down from US$1.06b, one year before. On the flip side, it has US$359.5m in cash leading to net debt of about US$183.8m.

How Healthy Is Scorpio Tankers' Balance Sheet?

We can see from the most recent balance sheet that Scorpio Tankers had liabilities of US$428.9m falling due within a year, and liabilities of US$2.24b due beyond that. On the other hand, it had cash of US$359.5m and US$206.5m worth of receivables due within a year. So its liabilities total US$2.10b more than the combination of its cash and short-term receivables.

This is a mountain of leverage relative to its market capitalization of US$2.40b. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry.

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.

Scorpio Tankers has a very low debt to EBITDA ratio of 0.51 so it is strange to see weak interest coverage, with last year's EBIT being only 1.4 times the interest expense. So while we're not necessarily alarmed we think that its debt is far from trivial. We also note that Scorpio Tankers improved its EBIT from a last year's loss to a positive US$201m. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Scorpio Tankers 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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So it is important to check how much of its earnings before interest and tax (EBIT) converts to actual free cash flow. During the last year, Scorpio Tankers generated free cash flow amounting to a very robust 93% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.

Our View

Scorpio Tankers's interest cover and level of total liabilities definitely weigh on it, in our esteem. But its conversion of EBIT to free cash flow tells a very different story, and suggests some resilience. Looking at all the angles mentioned above, it does seem to us that Scorpio Tankers is a somewhat risky investment as a result of its debt. Not all risk is bad, as it can boost share price returns if it pays off, but this debt risk is worth keeping in mind. 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. We've identified 1 warning sign with Scorpio Tankers , and understanding them should be part of your investment process.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.