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. We can see that Marathon Petroleum Corporation (NYSE:MPC) does use debt in its business. 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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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.

View our latest analysis for Marathon Petroleum

How Much Debt Does Marathon Petroleum Carry?

You can click the graphic below for the historical numbers, but it shows that as of December 2023 Marathon Petroleum had US$28.5b of debt, an increase on US$26.8b, over one year. However, because it has a cash reserve of US$10.2b, its net debt is less, at about US$18.3b.

A Look At Marathon Petroleum's Liabilities

We can see from the most recent balance sheet that Marathon Petroleum had liabilities of US$20.2b falling due within a year, and liabilities of US$34.4b due beyond that. On the other hand, it had cash of US$10.2b and US$11.6b worth of receivables due within a year. So its liabilities total US$32.7b more than the combination of its cash and short-term receivables.

Marathon Petroleum has a very large market capitalization of US$72.3b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Marathon Petroleum has a low net debt to EBITDA ratio of only 1.3. And its EBIT easily covers its interest expense, being 14.8 times the size. So we're pretty relaxed about its super-conservative use of debt. It is just as well that Marathon Petroleum's load is not too heavy, because its EBIT was down 49% over the last year. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Marathon Petroleum can strengthen its balance sheet over time. 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 company can only pay off debt with cold hard cash, not accounting profits. So we always check how much of that EBIT is translated into free cash flow. During the last three years, Marathon Petroleum generated free cash flow amounting to a very robust 84% of its EBIT, more than we'd expect. That positions it well to pay down debt if desirable to do so.

Our View

Marathon Petroleum's EBIT growth rate was a real negative on this analysis, although the other factors we considered were considerably better. There's no doubt that its ability to to cover its interest expense with its EBIT is pretty flash. When we consider all the factors mentioned above, we do feel a bit cautious about Marathon Petroleum's use of debt. While debt does have its upside in higher potential returns, we think shareholders should definitely consider how debt levels might make the stock more risky. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. Be aware that Marathon Petroleum is showing 4 warning signs in our investment analysis , and 1 of those shouldn't be ignored...

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.