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 Alvopetro Energy Ltd. (CVE:ALV) does use debt in its business. But should shareholders be worried about its use of debt?
When Is Debt A Problem?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. 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 examine debt levels, we first consider both cash and debt levels, together.
See our latest analysis for Alvopetro Energy
What Is Alvopetro Energy's Debt?
The image below, which you can click on for greater detail, shows that Alvopetro Energy had debt of US$6.55m at the end of September 2021, a reduction from US$15.3m over a year. However, its balance sheet shows it holds US$8.08m in cash, so it actually has US$1.54m net cash.
How Strong Is Alvopetro Energy's Balance Sheet?
We can see from the most recent balance sheet that Alvopetro Energy had liabilities of US$6.36m falling due within a year, and liabilities of US$15.0m due beyond that. Offsetting these obligations, it had cash of US$8.08m as well as receivables valued at US$4.56m due within 12 months. So it has liabilities totalling US$8.70m more than its cash and near-term receivables, combined.
Since publicly traded Alvopetro Energy shares are worth a total of US$117.8m, it seems unlikely that this level of liabilities would be a major threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. While it does have liabilities worth noting, Alvopetro Energy also has more cash than debt, so we're pretty confident it can manage its debt safely.
Notably, Alvopetro Energy made a loss at the EBIT level, last year, but improved that to positive EBIT of US$15m in the last twelve months. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Alvopetro Energy'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, a company can only pay off debt with cold hard cash, not accounting profits. While Alvopetro Energy has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Happily for any shareholders, Alvopetro Energy actually produced more free cash flow than EBIT over the last year. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.
While it is always sensible to look at a company's total liabilities, it is very reassuring that Alvopetro Energy has US$1.54m in net cash. The cherry on top was that in converted 113% of that EBIT to free cash flow, bringing in US$17m. So we are not troubled with Alvopetro Energy's debt use. 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. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for Alvopetro Energy 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.