Ogopogo007 wrote: Warren Buffett famously said, 'Volatility is far from synonymous with risk.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. Importantly, AltaGas Ltd. (TSE:ALA) does carry debt. But the real question is whether this debt is making the company risky.
What Risk Does Debt Bring?
Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.
Check out our latest analysis for AltaGas
How Much Debt Does AltaGas Carry?
You can click the graphic below for the historical numbers, but it shows that as of June 2019 AltaGas had CA$8.11b of debt, an increase on CA$3.46b, over one year. And it doesn't have much cash, so its net debt is about the same.
A Look At AltaGas's Liabilities
We can see from the most recent balance sheet that AltaGas had liabilities of CA$3.87b falling due within a year, and liabilities of CA$9.49b due beyond that. On the other hand, it had cash of CA$46.3m and CA$983.1m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by CA$12.3b.
This deficit casts a shadow over the CA$5.02b company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. At the end of the day, AltaGas would probably need a major re-capitalization if its creditors were to demand repayment.
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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.
Weak interest cover of 1.7 times and a disturbingly high net debt to EBITDA ratio of 6.9 hit our confidence in AltaGas like a one-two punch to the gut. The debt burden here is substantial. The good news is that AltaGas grew its EBIT a smooth 75% over the last twelve months. Like a mother's loving embrace of a newborn that sort of growth builds resilience, putting the company in a stronger position to manage its debt. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if AltaGas 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.
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. Over the last three years, AltaGas saw substantial negative free cash flow, in total. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.