Yahoo Finance Is Occidental Petroleum (NYSE:OXY) Using Too Much Debt?
Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. As with many other companies Occidental Petroleum Corporation (NYSE:OXY) makes use of debt. But is this debt a concern to shareholders?
When Is Debt A Problem?
Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.
See our latest analysis for Occidental Petroleum
What Is Occidental Petroleum's Debt?
You can click the graphic below for the historical numbers, but it shows that Occidental Petroleum had US$19.8b of debt in March 2023, down from US$26.3b, one year before. However, because it has a cash reserve of US$1.17b, its net debt is less, at about US$18.6b.
A Look At Occidental Petroleum's Liabilities
The latest balance sheet data shows that Occidental Petroleum had liabilities of US$7.44b due within a year, and liabilities of US$34.6b falling due after that. Offsetting this, it had US$1.17b in cash and US$3.27b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$37.6b.
This is a mountain of leverage even relative to its gargantuan market capitalization of US$52.2b. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry.
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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.
Occidental Petroleum has a low net debt to EBITDA ratio of only 0.96. And its EBIT covers its interest expense a whopping 22.0 times over. So you could argue it is no more threatened by its debt than an elephant is by a mouse. On top of that, Occidental Petroleum grew its EBIT by 68% over the last twelve months, and that growth will make it easier to handle its debt. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Occidental Petroleum's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.
Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So it's worth checking how much of that EBIT is backed by free cash flow. Over the last two years, Occidental Petroleum actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.
Our View
Happily, Occidental Petroleum's impressive interest cover implies it has the upper hand on its debt. But truth be told we feel its level of total liabilities does undermine this impression a bit. Zooming out, Occidental Petroleum seems to use debt quite reasonably; and that gets the nod from us. While debt does bring risk, when used wisely it can also bring a higher return on equity. 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. Be aware that Occidental Petroleum is showing 2 warning signs in our investment analysis , and 1 of those can't be ignored...
At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.
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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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