Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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, Paramount Resources Ltd. (TSE:POU) does carry debt. But should shareholders be worried about its use of debt?
When Is Debt A Problem?
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. 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, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.
What Is Paramount Resources's Net Debt?
As you can see below, at the end of June 2019, Paramount Resources had CA$926.4m of debt, up from CA$758.9m a year ago. Click the image for more detail. However, it does have CA$19.3m in cash offsetting this, leading to net debt of about CA$907.1m.
A Look At Paramount Resources's Liabilities
We can see from the most recent balance sheet that Paramount Resources had liabilities of CA$243.8m falling due within a year, and liabilities of CA$1.75b due beyond that. On the other hand, it had cash of CA$19.3m and CA$100.3m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by CA$1.88b.
The deficiency here weighs heavily on the CA$911.2m company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we'd watch its balance sheet closely, without a doubt At the end of the day, Paramount Resources would probably need a major re-capitalization if its creditors were to demand repayment. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Paramount Resources can strengthen its balance sheet over time. 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 Paramount Resources managed to grow its revenue by 2.6%, to CA$846m. That rate of growth is a bit slow for our taste, but it takes all types to make a world.
Importantly, Paramount Resources had negative earnings before interest and tax (EBIT), over the last year. Indeed, it lost a very considerable CA$437m at the EBIT level. 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 burned through CA$244m in negative free cash flow over the last year. So suffice it to say we consider the stock to be risky. When I consider a company to be a bit risky, I think it is responsible to check out whether insiders have been reporting any share sales. Luckily, you can click here ito see our graphic depicting Paramount Resources insider transactions.
When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.
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