Tourmaline Oil (TSE:TOU) Seems to Use Debt Sparingly
Legendary fund manager Li Lu (whom Charlie Munger once backed) once said, “The greatest risk in investing is not price volatility, but whether you will suffer a permanent loss of capital. It’s natural to consider a company’s balance sheet when looking at its riskiness, as debt is often involved when a company fails. Above all, Tourmaline Oil Corp. (TSE:TOU) is in debt. But the real question is whether this debt makes the business risky.
Why is debt risky?
Debt helps a business until the business struggles to pay it back, either with new capital or with free cash flow. In the worst case, a company can go bankrupt if it cannot pay its creditors. However, a more common (but still costly) 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 think about a company’s use of debt, we first look at cash and debt together.
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How Much Debt Does Tourmaline Oil Carry?
You can click on the chart below for historical numbers, but it shows Tourmaline Oil had C$614.5 million in debt in March 2022, up from C$1.47 billion a year prior. However, since it has a cash reserve of C$211.1 million, its net debt is less, at around C$403.5 million.
A Look at Tourmaline Oil Passives
According to the last published balance sheet, Tourmaline Oil had liabilities of C$1.56 billion due within 12 months and liabilities of C$2.45 billion due beyond 12 months. On the other hand, it had liquid assets of 211.1 million Canadian dollars and 761.3 million Canadian dollars of receivables due within one year. It therefore has liabilities totaling C$3.04 billion more than its cash and short-term receivables, combined.
Given that Tourmaline Oil has a colossal market capitalization of C$24.3 billion, it’s hard to believe that these liabilities pose much of a threat. But there are enough liabilities that we certainly recommend that shareholders continue to monitor the balance sheet in the future.
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). Thus, we consider debt to earnings with and without amortization and depreciation expense.
Tourmaline Oil has a low net debt to EBITDA ratio of just 0.14. And its EBIT covers its interest charges 128 times. One could therefore say that he is no more threatened by his debt than an elephant is by a mouse. What is even more impressive is that Tourmaline Oil increased its EBIT by 288% year-over-year. This boost will make paying off debt even easier in the future. When analyzing debt levels, the balance sheet is the obvious starting point. But ultimately, the company’s future profitability will decide whether Tourmaline Oil can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free analyst earnings forecast report interesting.
But our last consideration is also important, because a company cannot pay debt with paper profits; he needs cash. So the logical step is to look at what proportion of that EBIT is actual free cash flow. Over the past three years, Tourmaline Oil has produced strong free cash flow equivalent to 55% of its EBIT, which is what we expected. This free cash flow puts the company in a good position to repay its debt, should it arise.
Our point of view
Fortunately, Tourmaline Oil’s impressive interest coverage means it has the upper hand on its debt. And this is only the beginning of good news since its EBIT growth rate is also very encouraging. Looking at the big picture, we think Tourmaline Oil’s use of debt seems entirely reasonable and we’re not worried about that. Although debt carries risks, when used wisely, it can also generate a higher return on equity. 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 – tourmaline oil has 4 warning signs we think you should know.
In the end, it’s often best to focus on companies that aren’t in debt. You can access our special list of these companies (all with a track record of earnings growth). It’s free.
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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.