Does Petrus Resources (TSE:PRQ) have a healthy balance sheet?

Howard Marks said it well when he said that, rather than worrying about stock price volatility, “the possibility of permanent loss is the risk I worry about…and that every practical investor that I know is worried”. So it seems smart money knows that debt – which is usually involved in bankruptcies – is a very important factor when you’re assessing a company’s risk. We can see that Petrus Resources Ltd. (TSE:PRQ) uses debt in its business. But the real question is whether this debt makes the business risky.

What risk does debt carry?

Generally speaking, debt only becomes a real problem when a company cannot easily repay it, either by raising capital or with its own cash flow. An integral part of capitalism is the process of “creative destruction” where bankrupt companies are mercilessly liquidated by their bankers. Although not too common, we often see companies in debt permanently diluting their shareholders because lenders force them to raise capital at a ridiculous price. Of course, the advantage of debt is that it often represents cheap capital, especially when it replaces dilution in a business 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.

Discover our latest analysis for Petrus Resources

What is Petrus Resources net debt?

As you can see below, Petrus Resources had C$59.5 million in debt as of September 2021, up from C$115.8 million the previous year. On the other hand, it has C$1.51 million in cash, resulting in a net debt of approximately C$58.0 million.

TSX:PRQ Debt to Equity Historical February 20, 2022

A look at the liabilities of Petrus Resources

Zooming in on the latest balance sheet data, we can see that Petrus Resources had liabilities of C$79.5 million due within 12 months and liabilities of C$40.2 million due beyond. On the other hand, it had liquid assets of 1.51 million Canadian dollars and 9.16 million Canadian dollars of receivables due within one year. Thus, its liabilities outweigh the sum of its cash and (current) receivables of C$109.0 million.

This deficit is considerable compared to its market capitalization of 149.2 million Canadian dollars, so it suggests that shareholders monitor the use of debt by Petrus Resources. If its lenders asked it to shore up its balance sheet, shareholders would likely face significant dilution.

In order to assess a company’s debt relative to its earnings, we calculate its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and its earnings before interest and taxes (EBIT) divided by its expenses. interest (its interest coverage). In this way, we consider both the absolute amount of debt, as well as the interest rates paid on it.

Even though Petrus Resources’ debt is only 2.2, its interest coverage is really very low at 0.27. The main reason for this is that it has such high depreciation and amortization. These fees may be non-monetary, so they could be excluded when it comes to repaying the debt. But accounting fees are there for a reason: some assets seem to lose value. Either way, it’s safe to say that the company has significant debt. Notably, Petrus Resources recorded a loss in EBIT last year, but improved it to a positive EBIT of C$2.6 million over the last twelve months. There is no doubt that we learn the most about debt from the balance sheet. But you can’t look at debt in total isolation; since Petrus Resources will need revenue to repay this debt. So, if you want to know more about its earnings, it might be worth checking out this graph of its long-term trend.

Finally, while the taxman may love accounting profits, lenders only accept cash. It is therefore important to check how much of its earnings before interest and taxes (EBIT) converts into actual free cash flow. Fortunately for all shareholders, Petrus Resources has actually produced more free cash flow than EBIT over the past year. This kind of high cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Our point of view

Neither the ability of Petrus Resources to cover its interest charges with its EBIT nor its level of total liabilities gave us confidence in its ability to take on more debt. But the good news is that it seems to be able to easily convert EBIT to free cash flow. We think Petrus Resources’ debt makes it a bit risky, after looking at the aforementioned data points together. Not all risk is bad, as it can increase stock price returns if it pays off, but this leverage risk is worth keeping in mind. When analyzing debt levels, the balance sheet is the obvious starting point. But at the end of the day, every business can contain risks that exist outside of the balance sheet. Be aware that Petrus Resources displays 2 warning signs in our investment analysis and 1 of them does not suit us too much…

Of course, if you’re the type of investor who prefers to buy stocks without the burden of debt, then feel free to check out our exclusive list of cash-efficient growth stocks today.

This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.

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