Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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. Importantly, HighPeak Energy, Inc. (NASDAQ:HPK) does carry debt. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

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. 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 thing to do when considering how much debt a business uses is to look at its cash and debt together.

What Is HighPeak Energy's Debt?

As you can see below, HighPeak Energy had US$1.07b of debt at September 2024, down from US$1.15b a year prior. However, it also had US$135.6m in cash, and so its net debt is US$938.3m.

How Strong Is HighPeak Energy's Balance Sheet?

We can see from the most recent balance sheet that HighPeak Energy had liabilities of US$259.6m falling due within a year, and liabilities of US$1.20b due beyond that. Offsetting this, it had US$135.6m in cash and US$73.5m in receivables that were due within 12 months. So its liabilities total US$1.25b more than the combination of its cash and short-term receivables.

This deficit is considerable relative to its market capitalization of US$1.77b, so it does suggest shareholders should keep an eye on HighPeak Energy's use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.

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.

HighPeak Energy has a very low debt to EBITDA ratio of 1.0 so it is strange to see weak interest coverage, with last year's EBIT being only 2.2 times the interest expense. So one way or the other, it's clear the debt levels are not trivial. The bad news is that HighPeak Energy saw its EBIT decline by 18% over the last year. If earnings continue to decline at that rate then handling the debt will be more difficult than taking three children under 5 to a fancy pants restaurant. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine HighPeak Energy'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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. During the last three years, HighPeak Energy burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

To be frank both HighPeak Energy's EBIT growth rate and its track record of converting EBIT to free cash flow make us rather uncomfortable with its debt levels. But on the bright side, its net debt to EBITDA is a good sign, and makes us more optimistic. Overall, it seems to us that HighPeak Energy's balance sheet is really quite a risk to the business. For this reason we're pretty cautious about the stock, and we think shareholders should keep a close eye on its liquidity. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should be aware of the 1 warning sign we've spotted with HighPeak Energy .

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.