The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital. It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We can see that Patterson-UTI Energy, Inc. (NASDAQ:PTEN) does use debt in its business. But should shareholders be worried about its use of debt?
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. 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, 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 examine debt levels, we first consider both cash and debt levels, together.
What Is Patterson-UTI Energy's Net Debt?
As you can see below, Patterson-UTI Energy had US$1.12b of debt, at June 2019, which is about the same the year before. You can click the chart for greater detail. On the flip side, it has US$255.5m in cash leading to net debt of about US$864.1m.
A Look At Patterson-UTI Energy's Liabilities
Zooming in on the latest balance sheet data, we can see that Patterson-UTI Energy had liabilities of US$470.0m due within 12 months and liabilities of US$1.44b due beyond that. Offsetting this, it had US$255.5m in cash and US$507.2m in receivables that were due within 12 months. So its liabilities total US$1.15b more than the combination of its cash and short-term receivables.
This is a mountain of leverage relative to its market capitalization of US$1.84b. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe 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 Patterson-UTI Energy 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 Patterson-UTI Energy had negative earnings before interest and tax, and actually shrunk its revenue by 3.0%, to US$3.0b. That's not what we would hope to see.
Importantly, Patterson-UTI Energy had negative earnings before interest and tax (EBIT), over the last year. Indeed, it lost US$108m at the EBIT level. 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. We would feel better if it turned its trailing twelve month loss of US$354m into a profit. So in short it's a really risky stock. For riskier companies like Patterson-UTI Energy 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.
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.
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