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These 4 Measures Indicate That Australis Oil & Gas (ASX:ATS) Is Using Debt Reasonably Well

Simply Wall St

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital. So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We note that Australis Oil & Gas Limited (ASX:ATS) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Australis Oil & Gas

How Much Debt Does Australis Oil & Gas Carry?

You can click the graphic below for the historical numbers, but it shows that as of June 2019 Australis Oil & Gas had US$18.1m of debt, an increase on none, over one year. But it also has US$29.7m in cash to offset that, meaning it has US$11.6m net cash.

ASX:ATS Historical Debt, October 5th 2019

How Healthy Is Australis Oil & Gas's Balance Sheet?

We can see from the most recent balance sheet that Australis Oil & Gas had liabilities of US$24.8m falling due within a year, and liabilities of US$16.8m due beyond that. Offsetting these obligations, it had cash of US$29.7m as well as receivables valued at US$6.70m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$5.16m.

Since publicly traded Australis Oil & Gas shares are worth a total of US$116.3m, it seems unlikely that this level of liabilities would be a major threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. While it does have liabilities worth noting, Australis Oil & Gas also has more cash than debt, so we're pretty confident it can manage its debt safely.

Even more impressive was the fact that Australis Oil & Gas grew its EBIT by 120% over twelve months. If maintained that growth will make the debt even more manageable in the years ahead. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Australis Oil & Gas's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Australis Oil & Gas may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Over the last two years, Australis Oil & Gas saw substantial negative free cash flow, in total. 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.

Summing up

While it is always sensible to look at a company's total liabilities, it is very reassuring that Australis Oil & Gas has US$11.6m in net cash. And we liked the look of last year's 120% year-on-year EBIT growth. So we are not troubled with Australis Oil & Gas's debt use. Of course, we wouldn't say no to the extra confidence that we'd gain if we knew that Australis Oil & Gas insiders have been buying shares: if you're on the same wavelength, you can find out if insiders are buying by clicking this link.

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.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.

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.