Share Dilution

Vermilion Energy (TSE: VET) has a somewhat strained balance sheet


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Howard Marks put it well when he said that, rather than worrying about stock price volatility, “The possibility of permanent loss is the risk I worry about … and every investor practice that I know is worried “. So it can be obvious that you need to consider debt, when you think about how risky a given stock is, because too much debt can sink a business. We note that Vermillon Energy Inc. (TSE: VET) has debt on its balance sheet. But the most important question is: what risk does this debt create?

When Is Debt a Problem?

Debts and other liabilities become risky for a business when it cannot easily meet these obligations, either with free cash flow or by raising capital at an attractive price. Ultimately, if the company cannot meet its legal debt repayment obligations, shareholders could walk away with nothing. However, a more common (but still painful) scenario is that he must raise new equity at low cost, thereby diluting shareholders over the long term. 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. When we think of a business’s use of debt, we first look at cash flow and debt together.

See our latest review for Vermilion Energy

What is Vermilion Energy’s debt?

The image below, which you can click for more details, shows Vermilion Energy had C $ 1.77 billion in debt at the end of June 2021, a reduction from $ 2.14 billion. Canadians over one year. And he doesn’t have a lot of cash, so his net debt is about the same.

TSX: VET Debt to Equity History September 24, 2021

How strong is Vermilion Energy’s balance sheet?

Zooming in on the latest balance sheet data, we can see that Vermilion Energy had a liability of C $ 528.2 million due within 12 months and a liability of C $ 3.02 billion beyond. In compensation for these obligations, it had cash of CA $ 3.60 million as well as receivables valued at CA $ 205.9 million due within 12 months. Its liabilities therefore total C $ 3.34 billion more than the combination of its cash and short-term receivables.

This deficit casts a shadow over the C $ 1.64 billion company, like a colossus towering over mere mortals. We would therefore monitor its record closely, without a doubt. Ultimately, Vermilion Energy would likely need a major recapitalization if its creditors demanded repayment.

We measure a company’s debt load relative to its earning capacity 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 interests. costs (interest coverage). Thus, we consider debt versus earnings with and without amortization charges.

Vermilion Energy’s net debt is only 0.53 times its EBITDA. And its EBIT covers its interest expense 36.0 times more. We could therefore say that he is no more threatened by his debt than an elephant is by a mouse. It was also good to see that despite losing money on the EBIT line last year, Vermilion Energy has been a game changer over the past 12 months, delivering EBIT of C $ 2.7 billion. There is no doubt that we learn the most about debt from the balance sheet. But ultimately, the company’s future profitability will decide whether Vermilion Energy can strengthen its balance sheet over time. So, if you want to see what the professionals think, you might find this free analyst earnings forecast report interesting.

But our last consideration is also important, because a business cannot pay its debts with paper profits; he needs hard cash. It is therefore important to check to what extent its earnings before interest and taxes (EBIT) translate into actual free cash flow. Over the past year, Vermilion Energy has created free cash flow of 11% of EBIT, a performance of no interest. For us, the conversion to cash that elicits a bit of paranoia is the ability to extinguish debt.

Our point of view

Reflecting on Vermilion Energy’s attempt to stay on top of its total liabilities, we’re certainly not enthusiastic. But on the bright side, his interest coverage is a good sign and makes us more optimistic. Overall, we think it’s fair to say that Vermilion Energy has enough debt that there is real risk around the balance sheet. If all goes well it may pay off, but the downside to this debt is a greater risk of permanent losses. 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 off the balance sheet. We have identified 5 warning signs with Vermilion Energy (at least 1 of concern), and understanding them should be part of your investment process.

Of course, if you are the type of investor who prefers to buy stocks without going into debt, feel free to check out our exclusive list of cash net 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 using only unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell shares and does not take into account your goals or your financial situation. Our aim is to bring you long-term, targeted analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price sensitive companies or qualitative documents. Simply Wall St has no position in the mentioned stocks.
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