Berkshire Hathaway’s Charlie Munger-backed outside fund manager Li Lu is quick to say, “The biggest risk in investing isn’t price volatility, but whether you’re going to suffer a permanent loss of capital “. So it may be obvious that you need to take debt into account when thinking about the risk of a given stock, because too much debt can sink a business. Like many other companies Oceaneering International, Inc. (NYSE:OII) uses debt. But the more important question is: what risk does this debt create?
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. If things go really bad, lenders can take over the business. Although not too common, we often see companies in debt permanently diluting their shareholders because lenders force them to raise capital at a ridiculous price. Of course, many companies use debt to finance their growth, without any negative consequences. When we look at debt levels, we first consider cash and debt levels, together.
See our latest analysis for Oceaneering International
What is Oceaneering International’s debt?
You can click on the chart below for historical numbers, but it shows Oceaneering International had $701.8 million in debt in March 2022, up from $804.9 million a year prior. However, he has $444.2 million in cash to offset this, resulting in a net debt of approximately $257.6 million.
How strong is Oceaneering International’s balance sheet?
The latest balance sheet data shows that Oceaneering International had liabilities of $465.4 million due within the year, and liabilities of $934.5 million due thereafter. As compensation for these obligations, it had cash of US$444.2 million and receivables valued at US$475.4 million due within 12 months. Thus, its liabilities outweigh the sum of its cash and receivables (current) by $480.3 million.
While that might sound like a lot, it’s not too bad since Oceaneering International has a market capitalization of $981.5 million and therefore could likely bolster its balance sheet by raising capital if needed. But we definitely want to keep our eyes peeled for indications that its debt is too risky.
In order to assess a company’s debt relative to its earnings, we calculate its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and its earnings before interest and taxes (EBIT) divided by its expenses. interest (its 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 ).
While Oceaneering International has a quite reasonable net debt to EBITDA ratio of 1.6, its interest coverage looks low at 0.71. A big part of it is that it has so much depreciation and amortization. While companies often boast that these fees are not cash, most of these companies will therefore require an ongoing investment (which is not spent). Either way, it’s safe to say the company has significant debt. We also note that Oceaneering International improved its EBIT from last year’s loss to a positive result of $25 million. The balance sheet is clearly the area to focus on when analyzing debt. But ultimately, the company’s future profitability will decide whether Oceaneering International 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.
Finally, a business needs free cash flow to pay off its debts; book profits are not enough. It is therefore important to check how much of its earnings before interest and taxes (EBIT) converts into actual free cash flow. Fortunately for all shareholders, Oceaneering International has actually produced more free cash flow than EBIT over the past year. This kind of strong cash generation warms our hearts like a puppy in a bumblebee suit.
Our point of view
From what we’ve seen, Oceaneering International doesn’t find it easy, given its interest coverage, but the other factors we’ve considered give us cause for optimism. In particular, we are blown away by its conversion of EBIT to free cash flow. When we consider all the factors mentioned above, we feel a bit cautious about Oceaneering International’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. But at the end of the day, every business can contain risks that exist outside of the balance sheet. To this end, you should be aware of the 1 warning sign we spotted with Oceaneering International.
Of course, if you’re the type of investor who prefers to buy stocks without the burden of debt, then feel free to check out our exclusive list of cash-efficient growth stocks today.
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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.