Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We can see that Kosmos Energy Ltd. (NYSE:KOS) does use debt in its business. But should shareholders be worried about its use of debt?
What Risk Does Debt Bring?
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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.
What Is Kosmos Energy's Net Debt?
You can click the graphic below for the historical numbers, but it shows that as of March 2019 Kosmos Energy had US$2.20b of debt, an increase on US$1.27b, over one year. On the flip side, it has US$134.4m in cash leading to net debt of about US$2.06b.
A Look At Kosmos Energy's Liabilities
According to the last reported balance sheet, Kosmos Energy had liabilities of US$413.7m due within 12 months, and liabilities of US$3.21b due beyond 12 months. Offsetting this, it had US$134.4m in cash and US$186.2m in receivables that were due within 12 months. So its liabilities total US$3.30b more than the combination of its cash and short-term receivables.
Given this deficit is actually higher than the company's market capitalization of US$2.30b, we think shareholders really should watch Kosmos Energy's debt levels, like a parent watching their child ride a bike for the first time. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer extensive dilution. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Kosmos Energy'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.
In the last year Kosmos Energy managed to grow its revenue by 77%, to US$1.1b. Shareholders probably have their fingers crossed that it can grow its way to profits.
While we can certainly savour Kosmos Energy's tasty revenue growth, its negative earnings before interest and tax (EBIT) leaves a bitter aftertaste. To be specific the EBIT loss came in at US$68m. When we look at that alongside the significant liabilities, we're not particularly confident about the company. It would need to improve its operations quickly for us to be interested in it. Not least because it had negative free cash flow of US$966m over the last twelve months. So suffice it to say we consider the stock to be risky. For riskier companies like Kosmos Energy I always like to keep an eye on the long term profit and revenue trends. Fortunately, you can click to see our interactive graph of its profit, revenue, and operating cashflow.
Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.
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