Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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 note that National Oilwell Varco, Inc. (NYSE:NOV) does have debt on its balance sheet. But is this debt a concern to shareholders?
Why Does Debt Bring Risk?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.
How Much Debt Does National Oilwell Varco Carry?
You can click the graphic below for the historical numbers, but it shows that National Oilwell Varco had US$2.48b of debt in June 2019, down from US$2.72b, one year before. However, it also had US$1.12b in cash, and so its net debt is US$1.36b.
How Strong Is National Oilwell Varco's Balance Sheet?
We can see from the most recent balance sheet that National Oilwell Varco had liabilities of US$2.22b falling due within a year, and liabilities of US$3.64b due beyond that. On the other hand, it had cash of US$1.12b and US$2.56b worth of receivables due within a year. So it has liabilities totalling US$2.18b more than its cash and near-term receivables, combined.
This deficit isn't so bad because National Oilwell Varco is worth US$7.19b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if National Oilwell Varco can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.
In the last year National Oilwell Varco managed to grow its revenue by 12%, to US$8.6b. We usually like to see faster growth from unprofitable companies, but each to their own.
Importantly, National Oilwell Varco had negative earnings before interest and tax (EBIT), over the last year. To be specific the EBIT loss came in at US$243m. When we look at that and recall the liabilities on its balance sheet, relative to cash, it seems unwise to us for the company to have any debt. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. For example, we would not want to see a repeat of last year's loss of-US$5.5b. So to be blunt we do think it is risky. For riskier companies like National Oilwell Varco I always like to keep an eye on whether insiders are buying or selling. So click here if you want to find out for yourself.
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.
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 firstname.lastname@example.org. 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.