Warren Buffett famously said, '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. As with many other companies National Energy Services Reunited Corp. (NASDAQ:NESR) makes use of debt. But the real question is whether this debt is making the company risky.
When Is Debt Dangerous?
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. If things get really bad, the lenders can take control of the business. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.
What Is National Energy Services Reunited's Debt?
As you can see below, at the end of June 2019, National Energy Services Reunited had US$366.5m of debt, up from US$305.7m a year ago. Click the image for more detail. However, it also had US$69.6m in cash, and so its net debt is US$296.9m.
How Healthy Is National Energy Services Reunited's Balance Sheet?
We can see from the most recent balance sheet that National Energy Services Reunited had liabilities of US$169.0m falling due within a year, and liabilities of US$424.0m due beyond that. Offsetting these obligations, it had cash of US$69.6m as well as receivables valued at US$217.3m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$306.0m.
This deficit isn't so bad because National Energy Services Reunited is worth US$636.2m, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.
We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.
While National Energy Services Reunited's low debt to EBITDA ratio of 1.1 suggests only modest use of debt, the fact that EBIT only covered the interest expense by 5.2 last year does give us pause. But the interest payments are certainly sufficient to have us thinking about how affordable its debt is. We also note that National Energy Services Reunited improved its EBIT from a last year's loss to a positive US$173m. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine National Energy Services Reunited's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.
Finally, a company can only pay off debt with cold hard cash, not accounting profits. So it's worth checking how much of the earnings before interest and tax (EBIT) is backed by free cash flow. Considering the last year, National Energy Services Reunited actually recorded a cash outflow, overall. Debt is usually more expensive, and almost always more risky in the hands of a company with negative free cash flow. Shareholders ought to hope for and improvement.
National Energy Services Reunited's struggle to convert EBIT to free cash flow had us second guessing its balance sheet strength, but the other data-points we considered were relatively redeeming. But on the bright side, its ability handle its debt, based on its EBITDA, isn't too shabby at all. Taking the abovementioned factors together we do think National Energy Services Reunited's debt poses some risks to the business. So while that leverage does boost returns on equity, we wouldn't really want to see it increase from here. Over time, share prices tend to follow earnings per share, so if you're interested in National Energy Services Reunited, you may well want to click here to check an interactive graph of its earnings per share history.
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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