These 4 Measures Indicate That Jutal Offshore Oil Services (HKG:3303) Is Using Debt Extensively
The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital. 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, Jutal Offshore Oil Services Limited (HKG:3303) does carry debt. But should shareholders be worried about its use of debt?
Why Does Debt Bring Risk?
Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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.
Check out our latest analysis for Jutal Offshore Oil Services
How Much Debt Does Jutal Offshore Oil Services Carry?
You can click the graphic below for the historical numbers, but it shows that Jutal Offshore Oil Services had CN¥557.6m of debt in June 2019, down from CN¥874.9m, one year before. On the flip side, it has CN¥476.8m in cash leading to net debt of about CN¥80.7m.
How Healthy Is Jutal Offshore Oil Services's Balance Sheet?
According to the last reported balance sheet, Jutal Offshore Oil Services had liabilities of CN¥1.09b due within 12 months, and liabilities of CN¥537.7m due beyond 12 months. Offsetting this, it had CN¥476.8m in cash and CN¥930.4m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥223.7m.
While this might seem like a lot, it is not so bad since Jutal Offshore Oil Services has a market capitalization of CN¥936.4m, and so it could probably strengthen its balance sheet by raising capital if it needed to. However, it is still worthwhile taking a close look at its ability to pay off debt.
We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.
Given net debt is only 0.46 times EBITDA, it is initially surprising to see that Jutal Offshore Oil Services's EBIT has low interest coverage of 0.22 times. So one way or the other, it's clear the debt levels are not trivial. Importantly, Jutal Offshore Oil Services's EBIT fell a jaw-dropping 90% in the last twelve months. If that decline continues then paying off debt will be harder than selling foie gras at a vegan convention. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Jutal Offshore Oil Services 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 that EBIT is backed by free cash flow. During the last two years, Jutal Offshore Oil Services burned a lot of cash. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.
Our View
On the face of it, Jutal Offshore Oil Services's conversion of EBIT to free cash flow left us tentative about the stock, and its EBIT growth rate was no more enticing than the one empty restaurant on the busiest night of the year. But on the bright side, its net debt to EBITDA is a good sign, and makes us more optimistic. Overall, we think it's fair to say that Jutal Offshore Oil Services has enough debt that there are some real risks around the balance sheet. If everything goes well that may pay off but the downside of this debt is a greater risk of permanent losses. While Jutal Offshore Oil Services didn't make a statutory profit in the last year, its positive EBIT suggests that profitability might not be far away.Click here to see if its earnings are heading in the right direction, over the medium term.
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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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.
