NewMed Energy – Limited Partnership (TLV:NWMD) seems to be using debt quite wisely

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett said “volatility is far from synonymous with risk.” It’s natural to consider a company’s balance sheet when looking at its riskiness, as debt is often involved when a company fails. We note that NewMed Energy – Limited Partnership (TLV:NWMD) has debt on its balance sheet. But should shareholders worry about its use of debt?

Why is debt risky?

Debt and other liabilities become risky for a business when it cannot easily meet those obligations, either with free cash flow or by raising capital at an attractive price. If things go really bad, lenders can take over the business. However, a more usual (but still expensive) situation is when a company has to dilute shareholders at a cheap share price just to keep debt under control. Of course, debt can be an important tool in businesses, especially capital-intensive businesses. When we look at debt levels, we first consider cash and debt levels, together.

See our latest analysis for NewMed Energy – Limited Partnership

What is NewMed Energy – Limited Partnership Debt?

You can click on the graph below for historical numbers, but it shows NewMed Energy – Limited Partnership had $2.21 billion in debt in June 2022, up from $3.25 billion a year prior. However, since he has a cash reserve of $271.6 million, his net debt is less, at around $1.94 billion.

How healthy is NewMed Energy – Limited Partnership Balance Sheet?

Zooming in on the latest balance sheet data, we can see that NewMed Energy – Limited Partnership had liabilities of US$617.1 million due within 12 months and liabilities of US$2.07 billion due beyond. In return, he had $271.6 million in cash and $350.3 million in receivables due within 12 months. It therefore has liabilities totaling $2.07 billion more than its cash and short-term receivables, combined.

This shortfall is sizable relative to its market capitalization of US$3.08 billion, so it suggests shareholders keep an eye on NewMed Energy – Limited Partnership’s use of debt. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet quickly.

We measure a company’s leverage against its earning power by looking at its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and calculating how easily its earnings before interest and taxes (EBIT ) covers its interest charge (interest coverage). The advantage of this approach is that we consider both the absolute amount of debt (with net debt to EBITDA) and the actual interest expense associated with that debt (with its interest coverage ratio ).

NewMed Energy – Limited Partnership has a debt to EBITDA ratio of 2.8 and its EBIT covered its interest expense 3.1 times. Taken together, this implies that, while we wouldn’t like to see debt levels increase, we think he can manage his current leverage. On a lighter note, NewMed Energy – Limited Partnership has increased its EBIT by 28% over the past year. If he can sustain that kind of improvement, his debt load will start to melt like glaciers in a warming world. There is no doubt that we learn the most about debt from the balance sheet. But it is the profits of NewMed Energy – Limited Partnership that will influence the balance sheet in the future. So, when considering debt, it is definitely worth looking at the earnings trend. Click here for an interactive preview.

Finally, a business needs free cash flow to pay off its debts; book profits are not enough. So the logical step is to look at what proportion of that EBIT is actual free cash flow. Over the past three years, NewMed Energy – Limited Partnership’s free cash flow amounted to 46% of its EBIT, less than expected. This low cash conversion makes debt management more difficult.

Our point of view

On the balance sheet, the most notable positive for NewMed Energy – Limited Partnership is the fact that it appears capable of growing its EBIT with confidence. But the other factors we noted above weren’t so encouraging. For example, his interest coverage makes us a little nervous about his debt. When we consider all the factors mentioned above, we feel a little cautious about NewMed Energy – Limited Partnership’s use of debt. While we understand that debt can improve returns on equity, we suggest shareholders keep a close eye on their level of debt, lest it increase. The balance sheet is clearly the area to focus on when analyzing debt. However, not all investment risks reside on the balance sheet, far from it. For example, NewMed Energy – Limited Partnership has 4 warning signs (and 2 that are a bit obnoxious) that we think you should know about.

In the end, sometimes it’s easier to focus on companies that don’t even need to take on debt. Readers can access a list of growth stocks with no net debt 100% freeat present.

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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.