The external fund manager backed by Berkshire Hathaway’s Charlie Munger, Li Lu, makes no bones about it when he says ‘The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.’ When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We note that EOG Resources, Inc. (NYSE:EOG) does have debt on its balance sheet. But should shareholders be worried about its use of debt?
Why Does Debt Bring Risk?
Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. If things get really bad, the lenders can take control of the business. 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. When we think about a company’s use of debt, we first look at cash and debt together.
See our latest analysis for EOG Resources
What Is EOG Resources’s Debt?
The chart below, which you can click on for greater detail, shows that EOG Resources had US$5.08b in debt in September 2022; about the same as the year before. However, its balance sheet shows it holds US$5.27b in cash, so it actually has US$188.0m net cash.
A Look At EOG Resources’ Liabilities
The latest balance sheet data shows that EOG Resources had liabilities of US$5.75b due within a year, and liabilities of US$10.9b falling due after that. Offsetting these obligations, it had cash of US$5.27b as well as receivables valued at US$3.44b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$7.93b.
Given EOG Resources has a humongous market capitalization of US$74.9b, it’s hard to believe these liabilities pose much threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. While it does have liabilities worth noting, EOG Resources also has more cash than debt, so we’re pretty confident it can manage its debt safely.
Even more impressive was the fact that EOG Resources grew its EBIT by 139% over twelve months. If maintained that growth will make the debt even more manageable in the years ahead. 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 EOG Resources can strengthen its balance sheet over time. So if you’re focused on the future you can check out this free report showing analyst profit forecasts.
Finally, a company can only pay off debt with cold hard cash, not accounting profits. While EOG Resources has net cash on its balance sheet, it’s still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Over the most recent three years, EOG Resources recorded free cash flow worth 79% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.
Summing Up
While EOG Resources does have more liabilities than liquid assets, it also has net cash of US$188.0m. And it impressed us with its EBIT growth of 139% over the last year. So we don’t think EOG Resources’s use of debt is risky. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet – far from it. For example EOG Resources has 2 warning signs (and 1 which is concerning) we think you should know about.
Of course, if you’re the type of investor who prefers buying stocks without the burden of debt, then don’t hesitate to discover our exclusive list of net cash growth stocks, today.
Valuation is complex, but we’re helping make it simple.
Find out whether EOG Resources is potentially over or undervalued by checking out our comprehensive analysis, which includes fair value estimates, risks and warnings, dividends, insider transactions and financial health.
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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
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