Berkshire Hathaway’s Charlie Munger-backed outside fund manager Li Lu is quick to say, “The biggest risk in investing isn’t price volatility, but whether you’re going to suffer a permanent loss of capital “. When we think of a company’s risk, we always like to look at its use of debt, because over-indebtedness can lead to ruin. Above all, Chevron Company (NYSE:CVX) is in debt. But does this debt worry shareholders?
When is debt a problem?
Debt is a tool to help businesses grow, but if a business is unable to repay its lenders, it exists at their mercy. An integral part of capitalism is the process of “creative destruction” where bankrupt companies are mercilessly liquidated by their bankers. However, a more usual (but still expensive) situation is when a company has to dilute shareholders at a cheap share price just to keep debt under control. Of course, many companies use debt to finance their growth, without any negative consequences. When we look at debt levels, we first consider cash and debt levels, together.
See our latest analysis for Chevron
What is Chevron’s net debt?
You can click on the chart below for historical numbers, but it shows Chevron had $34.9 billion in debt in December 2021, up from $45.4 billion a year prior. On the other hand, it has $5.68 billion in cash, resulting in a net debt of around $29.2 billion.
A look at Chevron’s responsibilities
Zooming in on the latest balance sheet data, we can see that Chevron had liabilities of US$26.8 billion due within 12 months and liabilities of US$72.8 billion due beyond. In return, it had $5.68 billion in cash and $18.2 billion in receivables due within 12 months. Thus, its liabilities outweigh the sum of its cash and (short-term) receivables by $75.8 billion.
While that might sound like a lot, it’s not that bad since Chevron has a huge market capitalization of US$307.8 billion, so it could likely bolster its balance sheet by raising capital if needed. But we definitely want to keep our eyes peeled for indications that its debt is too risky.
In order to assess a company’s debt relative to its earnings, we calculate its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and its earnings before interest and taxes (EBIT) divided by its expenses. interest (its interest coverage). The advantage of this approach is that we consider both the absolute amount of debt (with net debt to EBITDA) and the actual interest expense associated with that debt (with its interest coverage ratio ).
Chevron has a low net debt to EBITDA ratio of just 0.76. And its EBIT covers its interest charges 33.2 times. One 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, Chevron turned it around in the last 12 months, delivering an EBIT of US$22 billion. The balance sheet is clearly the area to focus on when analyzing debt. But future earnings, more than anything, will determine Chevron’s ability to maintain a healthy balance sheet in the future. So if you are focused on the future, you can check out this free report showing analyst earnings forecast.
But our last consideration is also important, because a company cannot pay debt with paper profits; he needs cash. It is therefore worth checking how much of earnings before interest and tax (EBIT) is supported by free cash flow. Fortunately for all shareholders, Chevron has actually produced more free cash flow than EBIT over the past year. This kind of strong cash generation warms our hearts like a puppy in a bumblebee suit.
Our point of view
Chevron’s interest coverage suggests he can manage his debt as easily as Cristiano Ronaldo could score a goal against an Under-14 keeper. And the good news doesn’t stop there, since its conversion of EBIT into free cash flow also confirms this impression! Given all of this data, it seems to us that Chevron is taking a pretty sensible approach to debt. While this carries some risk, it can also improve shareholder returns. The balance sheet is clearly the area to focus on when analyzing debt. However, not all investment risks reside on the balance sheet, far from it. Example: we have identified 1 warning sign for Chevron you should be aware.
If, after all that, you’re more interested in a fast-growing company with a strong balance sheet, check out our list of cash-flowing growth stocks without further ado.
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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.