Is Gibson Energy (TSE:GEI) A Risky Investment?

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.' 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. We can see that Gibson Energy Inc. (TSE:GEI) does use debt in its business. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. 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, 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 Gibson Energy

How Much Debt Does Gibson Energy Carry?

The chart below, which you can click on for greater detail, shows that Gibson Energy had CA$1.55b in debt in September 2022; about the same as the year before. However, because it has a cash reserve of CA$72.2m, its net debt is less, at about CA$1.48b.

How Strong Is Gibson Energy's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Gibson Energy had liabilities of CA$950.6m due within 12 months and liabilities of CA$1.85b due beyond that. Offsetting these obligations, it had cash of CA$72.2m as well as receivables valued at CA$752.0m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CA$1.98b.

This deficit isn't so bad because Gibson Energy is worth CA$3.48b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution.

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.

Gibson Energy's debt is 3.3 times its EBITDA, and its EBIT cover its interest expense 5.3 times over. Taken together this implies that, while we wouldn't want to see debt levels rise, we think it can handle its current leverage. Importantly, Gibson Energy grew its EBIT by 64% over the last twelve months, and that growth will make it easier to handle its debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Gibson Energy's ability to maintain a healthy balance sheet going forward. 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 business needs free cash flow to pay off debt; accounting profits just don't cut it. So it's worth checking how much of that EBIT is backed by free cash flow. During the last three years, Gibson Energy generated free cash flow amounting to a very robust 96% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.

Our View

Happily, Gibson Energy's impressive conversion of EBIT to free cash flow implies it has the upper hand on its debt. But truth be told we feel its net debt to EBITDA does undermine this impression a bit. All these things considered, it appears that Gibson Energy can comfortably handle its current debt levels. On the plus side, this leverage can boost shareholder returns, but the potential downside is more risk of loss, so it's worth monitoring the balance sheet. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that Gibson Energy is showing 4 warning signs in our investment analysis , and 1 of those is potentially serious...

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.