Is Transurban Group (ASX:TCL) Using Too Much Debt?

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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. As with many other companies Transurban Group (ASX:TCL) makes use of debt. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. 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. 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.

Check out our latest analysis for Transurban Group

What Is Transurban Group's Debt?

As you can see below, Transurban Group had AU$18.6b of debt, at December 2023, which is about the same as the year before. You can click the chart for greater detail. On the flip side, it has AU$1.76b in cash leading to net debt of about AU$16.9b.

A Look At Transurban Group's Liabilities

Zooming in on the latest balance sheet data, we can see that Transurban Group had liabilities of AU$4.14b due within 12 months and liabilities of AU$19.7b due beyond that. On the other hand, it had cash of AU$1.76b and AU$410.0m worth of receivables due within a year. So its liabilities total AU$21.6b more than the combination of its cash and short-term receivables.

While this might seem like a lot, it is not so bad since Transurban Group has a huge market capitalization of AU$41.2b, and so it could probably strengthen its balance sheet by raising capital if it needed to. 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.

Weak interest cover of 2.1 times and a disturbingly high net debt to EBITDA ratio of 7.8 hit our confidence in Transurban Group like a one-two punch to the gut. The debt burden here is substantial. On the other hand, Transurban Group grew its EBIT by 22% in the last year. If it can maintain that kind of improvement, its debt load will begin to melt away like glaciers in a warming world. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Transurban Group can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. In the last three years, Transurban Group's free cash flow amounted to 35% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Our View

While Transurban Group's interest cover makes us cautious about it, its track record of managing its debt, based on its EBITDA, is no better. But on the brighter side of life, its EBIT growth rate leaves us feeling more frolicsome. It's also worth noting that Transurban Group is in the Infrastructure industry, which is often considered to be quite defensive. We think that Transurban Group's debt does make it a bit risky, after considering the aforementioned data points together. 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. For example, we've discovered 2 warning signs for Transurban Group that you should be aware of before investing here.

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.