Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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. We can see that Newpark Resources, Inc. (NYSE:NR) does use debt in its business. But should shareholders be worried about its use of debt?
What Risk Does Debt Bring?
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, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.
Check out our latest analysis for Newpark Resources
How Much Debt Does Newpark Resources Carry?
The image below, which you can click on for greater detail, shows that Newpark Resources had debt of US$161.1m at the end of June 2019, a reduction from US$197.2m over a year. However, it does have US$49.0m in cash offsetting this, leading to net debt of about US$112.1m.
A Look At Newpark Resources's Liabilities
Zooming in on the latest balance sheet data, we can see that Newpark Resources had liabilities of US$144.2m due within 12 months and liabilities of US$224.1m due beyond that. On the other hand, it had cash of US$49.0m and US$249.2m worth of receivables due within a year. So its liabilities total US$70.1m more than the combination of its cash and short-term receivables.
Of course, Newpark Resources has a market capitalization of US$675.5m, so these liabilities are probably manageable. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time.
In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.
While Newpark Resources's low debt to EBITDA ratio of 1.3 suggests only modest use of debt, the fact that EBIT only covered the interest expense by 2.9 last year does give us pause. But the interest payments are certainly sufficient to have us thinking about how affordable its debt is. Sadly, Newpark Resources's EBIT actually dropped 7.8% in the last year. If earnings continue on that decline then managing that debt will be difficult like delivering hot soup on a unicycle. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Newpark 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.