David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' 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. Importantly, Devon Energy Corporation (NYSE:DVN) does carry debt. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

How Much Debt Does Devon Energy Carry?

You can click the graphic below for the historical numbers, but it shows that as of September 2024 Devon Energy had US$8.88b of debt, an increase on US$6.16b, over one year. On the flip side, it has US$645.0m in cash leading to net debt of about US$8.24b.

How Healthy Is Devon Energy's Balance Sheet?

We can see from the most recent balance sheet that Devon Energy had liabilities of US$2.91b falling due within a year, and liabilities of US$12.9b due beyond that. Offsetting this, it had US$645.0m in cash and US$1.78b in receivables that were due within 12 months. So it has liabilities totalling US$13.4b more than its cash and near-term receivables, combined.

This is a mountain of leverage even relative to its gargantuan market capitalization of US$22.3b. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Devon Energy has a low net debt to EBITDA ratio of only 1.1. And its EBIT easily covers its interest expense, being 15.4 times the size. So we're pretty relaxed about its super-conservative use of debt. On the other hand, Devon Energy saw its EBIT drop by 6.2% in the last twelve months. If earnings continue to decline at that rate the company may have increasing difficulty managing its debt load. 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 Devon Energy's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Looking at the most recent three years, Devon Energy recorded free cash flow of 32% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

Our View

Neither Devon Energy's ability to grow its EBIT nor its level of total liabilities gave us confidence in its ability to take on more debt. But its interest cover tells a very different story, and suggests some resilience. Looking at all the angles mentioned above, it does seem to us that Devon Energy is a somewhat risky investment as a result of its debt. That's not necessarily a bad thing, since leverage can boost returns on equity, but it is something to be aware of. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. We've identified 5 warning signs with Devon Energy (at least 2 which shouldn't be ignored) , and understanding them should be part of your investment process.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.