Yahoo Finance Is Oryx Petroleum (TSE:OXC) Using Too Much Debt?
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 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. Importantly, Oryx Petroleum Corporation Limited (TSE:OXC) does carry debt. But should shareholders be worried about its use of debt?
When Is Debt A Problem?
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 usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.
Check out our latest analysis for Oryx Petroleum
What Is Oryx Petroleum's Net Debt?
The chart below, which you can click on for greater detail, shows that Oryx Petroleum had US$80.8m in debt in June 2019; about the same as the year before. However, it also had US$18.1m in cash, and so its net debt is US$62.7m.
A Look At Oryx Petroleum's Liabilities
We can see from the most recent balance sheet that Oryx Petroleum had liabilities of US$64.2m falling due within a year, and liabilities of US$142.3m due beyond that. On the other hand, it had cash of US$18.1m and US$25.1m worth of receivables due within a year. So it has liabilities totalling US$163.4m more than its cash and near-term receivables, combined.
Given this deficit is actually higher than the company's market capitalization of US$112.2m, we think shareholders really should watch Oryx Petroleum's debt levels, like a parent watching their child ride a bike for the first time. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer extensive dilution.
We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (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).
While Oryx Petroleum's low debt to EBITDA ratio of 0.69 suggests only modest use of debt, the fact that EBIT only covered the interest expense by 6.3 last year does give us pause. So we'd recommend keeping a close eye on the impact financing costs are having on the business. It was also good to see that despite losing money on the EBIT line last year, Oryx Petroleum turned things around in the last 12 months, delivering and EBIT of US$73m. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Oryx Petroleum will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.
Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So it's worth checking how much of the earnings before interest and tax (EBIT) is backed by free cash flow. In the last year, Oryx Petroleum created free cash flow amounting to 9.4% of its EBIT, an uninspiring performance. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.
Our View
We'd go so far as to say Oryx Petroleum's level of total liabilities was disappointing. But at least it's pretty decent at managing its debt, based on its EBITDA,; that's encouraging. We're quite clear that we consider Oryx Petroleum to be really rather risky, as a result of its balance sheet health. So we're almost as wary of this stock as a hungry kitten is about falling into its owner's fish pond: once bitten, twice shy, as they say. In light of our reservations about the company's balance sheet, it seems sensible to check if insiders have been selling shares recently.
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.
We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.
If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.
