Is Gibson Energy (TSE:GEI) Using Too Much Debt?

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, Gibson Energy Inc. (TSE:GEI) does carry debt. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

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. 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.

View our latest analysis for Gibson Energy

What Is Gibson Energy's Net Debt?

The image below, which you can click on for greater detail, shows that at September 2023 Gibson Energy had debt of CA$2.65b, up from CA$1.55b in one year. However, it also had CA$54.5m in cash, and so its net debt is CA$2.59b.

How Healthy Is Gibson Energy's Balance Sheet?

We can see from the most recent balance sheet that Gibson Energy had liabilities of CA$1.01b falling due within a year, and liabilities of CA$3.00b due beyond that. Offsetting this, it had CA$54.5m in cash and CA$789.1m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CA$3.16b.

This is a mountain of leverage relative to its market capitalization of CA$3.42b. 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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Gibson Energy has a rather high debt to EBITDA ratio of 5.5 which suggests a meaningful debt load. But the good news is that it boasts fairly comforting interest cover of 4.1 times, suggesting it can responsibly service its obligations. On a lighter note, we note that Gibson Energy grew its EBIT by 25% 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 Gibson Energy 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 it's worth checking how much of that EBIT is backed by free cash flow. Happily for any shareholders, Gibson Energy actually produced more free cash flow than EBIT over the last three years. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Our View

Both Gibson Energy's ability to to convert EBIT to free cash flow and its EBIT growth rate gave us comfort that it can handle its debt. In contrast, our confidence was undermined by its apparent struggle handle its debt, based on its EBITDA,. When we consider all the factors mentioned above, we do feel a bit cautious about Gibson Energy's use of debt. While debt does have its upside in higher potential returns, we think shareholders should definitely consider how debt levels might make the stock more risky. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. These risks can be hard to spot. Every company has them, and we've spotted 3 warning signs for Gibson Energy (of which 1 is a bit unpleasant!) 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.