Do petroleum refineries (TLV: ORL) have a healthy balance sheet?
Berkshire Hathaway’s Charlie Munger-backed external fund manager Li Lu is quick to say “The biggest risk in investing is not price volatility, but the fact that you suffer a permanent loss of capital. “. So it can be obvious that you need to consider debt, when you think about how risky a given stock is because too much debt can sink a business. Like many other companies Oil refineries Ltd. (TLV: ORL) uses debt. But the real question is whether this debt makes the business risky.
When is debt a problem?
Debt helps a business until the business struggles to repay it, either with new capital or with free cash flow. Ultimately, if the company cannot meet its legal debt repayment obligations, shareholders could walk away with nothing. While it’s not too common, we often see indebted companies continually diluting their shareholders because lenders are forcing them to raise capital at a ridiculous price. By replacing dilution, however, debt can be a very good tool for companies that need capital to invest in growth at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash flow and debt together.
See our latest analysis for petroleum refineries
What is the debt of the oil refineries?
The image below, which you can click for more details, shows oil refineries owed $ 1.52 billion in debt at the end of March 2021, a reduction from $ 1.74 billion. of US dollars over one year. However, given that it has a cash reserve of US $ 762.2 million, its net debt is less, at approximately US $ 754.9 million.
How strong is the balance sheet of oil refineries?
Zooming in on the latest balance sheet data, we can see that oil refineries had liabilities of US $ 1.37 billion due within 12 months and liabilities of US $ 1.67 billion due beyond. . In return, he had $ 762.2 million in cash and $ 504.6 million in receivables due within 12 months. Its liabilities therefore total US $ 1.78 billion more than the combination of its cash and short-term receivables.
This deficit casts a shadow over the $ 873.0 million company as a towering colossus of mere mortals. We therefore believe that shareholders should watch it closely. Ultimately, oil refineries would likely need a major recapitalization if their creditors demanded repayment.
We measure a company’s debt load relative to its earning capacity by looking at its net debt divided by its earnings before interest, taxes, depreciation, and amortization (EBITDA) and calculating how easily its earnings before interest and taxes (EBIT) covers its interest costs (interest coverage). Thus, we consider debt versus earnings with and without amortization charges.
While we’re not worried about oil refineries’ 3.2 net debt to EBITDA ratio, we do think its ultra-low 0.55 times interest coverage is a sign of high leverage. It appears that the company incurs significant depreciation and amortization costs, so perhaps its debt load is heavier than it first appears, since EBITDA is arguably a generous measure of profits. Shareholders should therefore probably be aware that interest charges seem to have had a real impact on the company in recent times. However, the bright side is that oil refineries have achieved a positive EBIT of US $ 58 million over the past twelve months, an improvement over the loss of the previous year. There is no doubt that we learn the most about debt from the balance sheet. But you can’t look at debt in isolation; since oil refineries will need revenue to pay off this debt. So, when considering debt, it is really worth looking at the profit trend. Click here for an interactive snapshot.
Finally, a business can only repay its debts with hard cash, not with book profits. It is therefore worth checking to what extent earnings before interest and taxes (EBIT) are backed by free cash flow. Over the past year, oil refineries have actually generated more free cash flow than EBIT. There is nothing better than cash flow to stay in the good graces of your lenders.
Our point of view
At first glance, the hedging of oil refinery interests left us hesitant about the stock, and its total liability level was no more appealing than the single empty restaurant on the busiest night of the year. But at least it’s pretty decent to convert EBIT into free cash flow; it’s encouraging. Overall, we think it’s fair to say that oil refineries have enough debt that there is real risk around the balance sheet. If all goes well, this should increase returns, but on the other hand, the risk of permanent capital loss is increased by debt. The balance sheet is clearly the area to focus on when analyzing debt. But at the end of the day, every business can contain risks that exist off the balance sheet. For example – oil refineries have 2 warning signs we think you should be aware.
If, after all of this, you’re more interested in a fast-growing company with a strong balance sheet, take a quick look at our list of cash net growth stocks.
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