These 4 Measures Indicate That Scorpio Tankers (NYSE:STNG) Is Using Debt Reasonably Well

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.' 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 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?

When Is Debt Dangerous?

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. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

View 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$295.6m of debt in December 2022, down from US$901.7m, one year before. But on the other hand it also has US$376.9m in cash, leading to a US$81.3m net cash position.

A Look At Scorpio Tankers' Liabilities

We can see from the most recent balance sheet that Scorpio Tankers had liabilities of US$473.3m falling due within a year, and liabilities of US$1.58b due beyond that. On the other hand, it had cash of US$376.9m and US$276.7m worth of receivables due within a year. So it has liabilities totalling US$1.40b more than its cash and near-term receivables, combined.

Scorpio Tankers has a market capitalization of US$3.30b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. While it does have liabilities worth noting, Scorpio Tankers also has more cash than debt, so we're pretty confident it can manage its debt safely.

It was also good to see that despite losing money on the EBIT line last year, Scorpio Tankers turned things around in the last 12 months, delivering and EBIT of US$851m. 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Scorpio Tankers 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. Over the last year, Scorpio Tankers recorded free cash flow worth a fulsome 90% of its EBIT, which is stronger than we'd usually expect. That positions it well to pay down debt if desirable to do so.

Summing Up

Although Scorpio Tankers's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of US$81.3m. And it impressed us with free cash flow of US$769m, being 90% of its EBIT. So we don't have any problem with Scorpio Tankers's use of debt. 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 example Scorpio Tankers has 2 warning signs (and 1 which can't be ignored) we think you should know about.

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.