AGL Energy (ASX:AGL) Has A Pretty Healthy Balance Sheet

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that '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. We can see that AGL Energy Limited (ASX:AGL) does use debt in its business. But should shareholders be worried about its use of debt?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for AGL Energy

What Is AGL Energy's Debt?

You can click the graphic below for the historical numbers, but it shows that as of December 2024 AGL Energy had AU$2.57b of debt, an increase on AU$2.45b, over one year. However, it does have AU$253.0m in cash offsetting this, leading to net debt of about AU$2.31b.

A Look At AGL Energy's Liabilities

According to the last reported balance sheet, AGL Energy had liabilities of AU$4.11b due within 12 months, and liabilities of AU$5.79b due beyond 12 months. On the other hand, it had cash of AU$253.0m and AU$1.78b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by AU$7.87b.

Given this deficit is actually higher than the company's market capitalization of AU$7.11b, we think shareholders really should watch AGL Energy's debt levels, like a parent watching their child ride a bike for the first time. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer extensive dilution.

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.

AGL Energy's net debt is only 1.3 times its EBITDA. And its EBIT covers its interest expense a whopping 11.5 times over. So we're pretty relaxed about its super-conservative use of debt. In addition to that, we're happy to report that AGL Energy has boosted its EBIT by 80%, thus reducing the spectre of future debt repayments. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine AGL 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 we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the most recent three years, AGL Energy recorded free cash flow worth 54% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Our View

AGL Energy's EBIT growth rate was a real positive on this analysis, as was its interest cover. In contrast, our confidence was undermined by its apparent struggle to handle its total liabilities. We would also note that Integrated Utilities industry companies like AGL Energy commonly do use debt without problems. When we consider all the elements mentioned above, it seems to us that AGL Energy is managing its debt quite well. But a word of caution: we think debt levels are high enough to justify ongoing monitoring. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 4 warning signs for AGL Energy you should be aware of.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.