Warren Buffett famously said, ‘Volatility is far from synonymous with risk.’ So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We note that Baytex Energy Corp. (TSE:BTE) does have debt on its balance sheet. But should shareholders be worried about its use of debt?
When Is Debt Dangerous?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can’t fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.
How Much Debt Does Baytex Energy Carry?
As you can see below, Baytex Energy had CA$1.78b of debt, at December 2020, which is about the same as the year before. You can click the chart for greater detail. Net debt is about the same, since the it doesn’t have much cash.
How Strong Is Baytex Energy’s Balance Sheet?
We can see from the most recent balance sheet that Baytex Energy had liabilities of CA$198.9m falling due within a year, and liabilities of CA$2.63b due beyond that. On the other hand, it had cash of CA$5.57m and CA$107.5m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by CA$2.72b.
This deficit casts a shadow over the CA$784.1m company, like a colossus towering over mere mortals. So we’d watch its balance sheet closely, without a doubt. At the end of the day, Baytex Energy would probably need a major re-capitalization if its creditors were to demand repayment. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Baytex Energy’s ability to maintain a healthy balance sheet going forward.
Over 12 months, Baytex Energy made a loss at the EBIT level, and saw its revenue drop to CA$812m, which is a fall of 45%. That makes us nervous, to say the least.
Not only did Baytex Energy’s revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). Its EBIT loss was a whopping CA$2.5b. Combining this information with the significant liabilities we already touched on makes us very hesitant about this stock, to say the least. That said, it is possible that the company will turn its fortunes around. But we think that is unlikely since it is low on liquid assets, and made a loss of CA$2.4b in the last year. So while it’s not wise to assume the company will fail, we do think it’s risky. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet.