Howard Marks put it nicely when he said that, rather than worrying about share price volatility, ‘The possibility of permanent loss is the risk I worry about… and every practical investor I know worries about.’ So it seems the smart money knows that debt – which is usually involved in bankruptcies – is a very important factor, when you assess how risky a company is. Importantly, Patterson-UTI Energy, Inc. (NASDAQ:PTEN) does carry debt. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

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. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

How Much Debt Does Patterson-UTI Energy Carry?

As you can see below, Patterson-UTI Energy had US$877.7m of debt, at June 2022, which is about the same as the year before. You can click the chart for greater detail. On the flip side, it has US$19.6m in cash leading to net debt of about US$858.1m.

A Look At Patterson-UTI Energy’s Liabilities

According to the last reported balance sheet, Patterson-UTI Energy had liabilities of US$448.4m due within 12 months, and liabilities of US$935.5m due beyond 12 months. Offsetting these obligations, it had cash of US$19.6m as well as receivables valued at US$473.3m due within 12 months. So it has liabilities totalling US$890.9m more than its cash and near-term receivables, combined.

While this might seem like a lot, it is not so bad since Patterson-UTI Energy has a market capitalization of US$3.03b, and so it could probably strengthen its balance sheet by raising capital if it needed to. However, it is still worthwhile taking a close look at its ability to pay off debt. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Patterson-UTI Energy can strengthen its balance sheet over time.

Over 12 months, Patterson-UTI Energy reported revenue of US$2.0b, which is a gain of 104%, although it did not report any earnings before interest and tax. So there’s no doubt that shareholders are cheering for growth

Caveat Emptor

Despite the top line growth, Patterson-UTI Energy still had an earnings before interest and tax (EBIT) loss over the last year. To be specific the EBIT loss came in at US$164m. Considering that alongside the liabilities mentioned above does not give us much confidence that company should be using so much debt. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. Another cause for caution is that is bled US$165m in negative free cash flow over the last twelve months. So in short it’s a really risky stock. The balance sheet is clearly the area to focus on when you are analysing debt.