Berkshire Hathaway’s Charlie Munger-backed external fund manager Li Lu is quick to say “The biggest risk in investing is not price volatility, but the fact that you suffer a permanent loss of capital. “. So it seems like smart money knows that debt – which is usually involved in bankruptcies – is a very important factor, when you assess the level of risk of a business. Above all, EOG Resources, Inc. (NYSE: EOG) carries debt. But the most important question is: what risk does this debt create?
What risk does debt entail?
Debt is a tool to help businesses grow, but if a business is unable to repay its lenders, then it exists at their mercy. If things really go wrong, lenders can take over the business. While it’s not too common, we often see indebted companies continually diluting their shareholders because lenders are forcing them to raise capital at a ridiculous price. That said, the most common situation is where a business manages its debt reasonably well – and to its own advantage. The first step in examining a company’s debt levels is to consider its cash flow and debt together.
What is the debt of EOG Resources?
The image below, which you can click for more details, shows that EOG Resources had $ 5.13 billion in debt at the end of June 2021, a reduction from $ 5.72 billion. US over one year. However, given that it has a cash reserve of US $ 3.88 billion, its net debt is less, at around US $ 1.25 billion.
NYSE: EOG Debt to Equity History October 25, 2021
A look at the responsibilities of EOG Resources
We can see from the most recent balance sheet that EOG Resources had liabilities of US $ 4.00 billion maturing within one year and liabilities of US $ 12.0 billion maturing within one year. of the. In compensation for these obligations, he had cash of US $ 3.88 billion as well as receivables valued at US $ 2.03 billion due within 12 months. Its liabilities therefore total US $ 10.1 billion more than the combination of its cash and short-term receivables.
Considering that EOG Resources has a whopping market cap of US $ 53.7 billion, it’s hard to believe that these liabilities pose a big threat. Having said that, it is clear that we must continue to monitor his record lest it get worse.
We measure a company’s indebtedness relative to its earning power by looking at its net debt divided by its earnings before interest, taxes, depreciation, and amortization (EBITDA) and calculating the ease with which its earnings before interest and taxes (EBIT ) covers its interests. costs (interest coverage). The advantage of this approach is that we take into account both the absolute amount of debt (with net debt versus EBITDA) and the actual interest charges associated with this debt (with its coverage rate). interests).
EOG Resources’ net debt is only 0.19 times its EBITDA. And its EBIT easily covers its interest costs, which is 14.1 times the size. So we’re pretty relaxed about its ultra-conservative use of debt. Even more impressive was the fact that EOG Resources increased its EBIT by 176% year over year. This boost will make it even easier to pay down debt in the future. There is no doubt that we learn the most about debt from the balance sheet. But ultimately, the company’s future profitability will decide whether EOG Resources 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 can only repay its debts with hard cash, not with book profits. We must therefore clearly check whether this EBIT generates a corresponding free cash flow. Over the past three years, EOG Resources has recorded free cash flow of 76% of its EBIT, which is close to normal given that free cash flow excludes interest and taxes. This free cash flow puts the business in a good position to repay debt, if any.
Our point of view
EOG Resources’ interest coverage suggests they can manage their debt as easily as Cristiano Ronaldo could score a goal against an Under-14 goalkeeper. And that’s just the start of good news as its EBIT growth rate is also very encouraging. Overall, we don’t think EOG Resources is taking bad risks, as its leverage appears modest. We are therefore not worried about the use of a small leverage on the balance sheet. When analyzing debt levels, the balance sheet is the obvious starting point. But at the end of the day, every business can contain risks that exist off the balance sheet. For example, we have identified 1 warning sign for EOG resources that you need to be aware of.
If, after all of this, you’re more interested in a fast-growing company with a strong balance sheet, take a quick look at our list of cash net growth stocks.
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