Scorpio Tankers (NYSE:STNG) Has A Pretty Healthy Balance Sheet

Legendary fund manager Li Lu (who Charlie Munger backed) once said, '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. We note that Scorpio Tankers Inc. (NYSE:STNG) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

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. If things get really bad, the lenders can take control of the business. 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. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest 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

How Much Debt Does Scorpio Tankers Carry?

The image below, which you can click on for greater detail, shows that Scorpio Tankers had debt of US$520.0m at the end of September 2022, a reduction from US$1.05b over a year. However, it does have US$467.6m in cash offsetting this, leading to net debt of about US$52.4m.

How Strong Is Scorpio Tankers' Balance Sheet?

The latest balance sheet data shows that Scorpio Tankers had liabilities of US$488.6m due within a year, and liabilities of US$2.04b falling due after that. Offsetting these obligations, it had cash of US$467.6m as well as receivables valued at US$247.0m due within 12 months. So its liabilities total US$1.82b more than the combination of its cash and short-term receivables.

This is a mountain of leverage relative to its market capitalization of US$2.82b. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry.

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). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

With net debt at just 0.075 times EBITDA, it seems Scorpio Tankers only uses a little bit of leverage. But EBIT was only 3.6 times the interest expense last year, so the borrowing is clearly weighing on the business somewhat. Notably, Scorpio Tankers made a loss at the EBIT level, last year, but improved that to positive EBIT of US$545m in the last twelve months. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Scorpio Tankers'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.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. 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 92% of its EBIT, more than we'd expect. That positions it well to pay down debt if desirable to do so.

Our View

Both Scorpio Tankers's ability to to convert EBIT to free cash flow and its net debt to EBITDA gave us comfort that it can handle its debt. On the other hand, its interest cover makes us a little less comfortable about its debt. Considering this range of data points, we think Scorpio Tankers is in a good position to manage its debt levels. Having said that, the load is sufficiently heavy that we would recommend any shareholders keep a close eye on it. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 1 warning sign for Scorpio Tankers that you should be aware of.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.