Is Gibson Energy (TSE:GEI) 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.' 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, Gibson Energy Inc. (TSE:GEI) does carry debt. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

Check out the opportunities and risks within the CA Oil and Gas industry.

How Much Debt Does Gibson Energy Carry?

The chart below, which you can click on for greater detail, shows that Gibson Energy had CA$1.58b in debt in June 2022; about the same as the year before. However, it does have CA$38.8m in cash offsetting this, leading to net debt of about CA$1.54b.

How Strong Is Gibson Energy's Balance Sheet?

We can see from the most recent balance sheet that Gibson Energy had liabilities of CA$1.19b falling due within a year, and liabilities of CA$1.86b due beyond that. Offsetting this, it had CA$38.8m in cash and CA$973.2m in receivables that were due within 12 months. So it has liabilities totalling CA$2.04b more than its cash and near-term receivables, combined.

This is a mountain of leverage relative to its market capitalization of CA$3.14b. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Gibson Energy's debt is 3.7 times its EBITDA, and its EBIT cover its interest expense 4.6 times over. This suggests that while the debt levels are significant, we'd stop short of calling them problematic. It is well worth noting that Gibson Energy's EBIT shot up like bamboo after rain, gaining 45% in the last twelve months. That'll make it easier to manage its debt. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Gibson Energy 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. During the last three years, Gibson Energy generated free cash flow amounting to a very robust 93% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.

Our View

Gibson Energy's conversion of EBIT to free cash flow suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. 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. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. Be aware that Gibson Energy is showing 2 warning signs in our investment analysis , you should know about...

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.