Is NewMed Energy – Limited Partnership (TLV:NWMD) a risky investment?
Legendary fund manager Li Lu (whom Charlie Munger once backed) once said, “The greatest risk in investing is not price volatility, but whether you will suffer a permanent loss of capital. 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. Like many other companies NewMed Energy – Limited Partnership (TLV:NWMD) uses debt. But the more important question is: what risk does this debt create?
When is debt dangerous?
Debt and other liabilities become risky for a business when it cannot easily meet those obligations, either with free cash flow or by raising capital at an attractive price. 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. The first step when considering a company’s debt levels is to consider its cash and debt together.
Check out our latest analysis for NewMed Energy – Limited Partnership
What is the net debt of NewMed Energy – Limited Partnership?
You can click on the chart below for historical numbers, but it shows that NewMed Energy – Limited Partnership had US$2.23 billion in debt in March 2022, up from US$3.25 billion a year earlier. On the other hand, it has $213.8 million in cash, resulting in a net debt of around $2.01 billion.
How healthy is NewMed Energy – Limited Partnership Balance Sheet?
We can see from the most recent balance sheet that NewMed Energy – Limited Partnership had liabilities of US$184.1 million due within one year, and liabilities of US$2.53 billion due to -of the. On the other hand, it had a cash position of $213.8 million and $266.9 million in receivables within one year. It therefore has liabilities totaling $2.23 billion more than its cash and short-term receivables, combined.
This is a mountain of leverage compared to its market capitalization of US$3.18 billion. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet quickly.
We measure a company’s leverage against its earning power 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 charge (interest coverage). Thus, we consider debt to earnings with and without amortization and depreciation expense.
NewMed Energy – Limited Partnership’s debt is 3.1 times its EBITDA, and its EBIT covers its interest expense 2.7 times. This suggests that while debt levels are significant, we will refrain from labeling them as problematic. The good news is that NewMed Energy – Limited Partnership has increased its EBIT by 41% over the last twelve months. Like a mother’s loving embrace of a newborn, this kind of growth builds resilience, putting the company in a stronger position to manage its debt. The balance sheet is clearly the area to focus on when analyzing debt. But you can’t look at debt in total isolation; since NewMed Energy – Limited Partnership will need revenue to repay this debt. So, when considering debt, it is definitely worth looking at the earnings trend. Click here for an interactive preview.
Finally, a company can only repay its debts with cold hard cash, not with book profits. It is therefore worth checking how much of this EBIT is supported by free cash flow. Over the last three years, NewMed Energy – Limited Partnership has recorded a free cash flow of 42% of its EBIT, which is lower than expected. This low cash conversion makes debt management more difficult.
Our point of view
Interest coverage and the level of total liabilities of NewMed Energy – Limited Partnership are certainly weighing on it, in our view. But its EBIT growth rate tells a very different story and suggests some resilience. Looking at all the angles mentioned above, it seems to us that NewMed Energy – Limited Partnership is a somewhat risky investment due to its debt. Not all risk is bad, as it can boost stock 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. For example, we have identified 4 warning signs for NewMed Energy – Limited Partnership (2 doesn’t sit too well with us) you should know.
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.
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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.