TC Energy (TSE:TRP) Use Of Debt Could Be Considered Risky

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a 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, TC Energy Corporation (TSE:TRP) 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. If things get really bad, the lenders can take control of the business. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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.

View our latest analysis for TC Energy

How Much Debt Does TC Energy Carry?

The image below, which you can click on for greater detail, shows that at September 2023 TC Energy had debt of CA$65.7b, up from CA$58.9b in one year. However, because it has a cash reserve of CA$3.28b, its net debt is less, at about CA$62.5b.

A Look At TC Energy's Liabilities

Zooming in on the latest balance sheet data, we can see that TC Energy had liabilities of CA$11.1b due within 12 months and liabilities of CA$77.6b due beyond that. Offsetting this, it had CA$3.28b in cash and CA$3.78b in receivables that were due within 12 months. So its liabilities total CA$81.6b more than the combination of its cash and short-term receivables.

The deficiency here weighs heavily on the CA$54.4b company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we definitely think shareholders need to watch this one closely. At the end of the day, TC Energy would probably need a major re-capitalization if its creditors were to demand repayment.

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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Weak interest cover of 1.6 times and a disturbingly high net debt to EBITDA ratio of 8.3 hit our confidence in TC Energy like a one-two punch to the gut. The debt burden here is substantial. Worse, TC Energy's EBIT was down 36% over the last year. If earnings continue to follow that trajectory, paying off that debt load will be harder than convincing us to run a marathon in the rain. 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 TC 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.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Considering the last three years, TC Energy actually recorded a cash outflow, overall. Debt is usually more expensive, and almost always more risky in the hands of a company with negative free cash flow. Shareholders ought to hope for an improvement.

Our View

To be frank both TC Energy's net debt to EBITDA and its track record of (not) growing its EBIT make us rather uncomfortable with its debt levels. And furthermore, its interest cover also fails to instill confidence. Considering everything we've mentioned above, it's fair to say that TC Energy is carrying heavy debt load. If you play with fire you risk getting burnt, so we'd probably give this stock a wide berth. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. For example, we've discovered 3 warning signs for TC Energy (2 are a bit concerning!) 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.