AltaGas (TSE:ALA) Seems To Be Using A Lot Of Debt

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We can see that AltaGas Ltd. (TSE:ALA) does use debt in its business. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. 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 thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for AltaGas

What Is AltaGas's Debt?

The image below, which you can click on for greater detail, shows that at June 2023 AltaGas had debt of CA$8.33b, up from CA$7.88b in one year. Net debt is about the same, since the it doesn't have much cash.

A Look At AltaGas' Liabilities

The latest balance sheet data shows that AltaGas had liabilities of CA$2.32b due within a year, and liabilities of CA$11.2b falling due after that. On the other hand, it had cash of CA$64.0m and CA$1.21b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by CA$12.2b.

The deficiency here weighs heavily on the CA$7.57b 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'd watch its balance sheet closely, without a doubt. After all, AltaGas would likely require a major re-capitalisation if it had to pay its creditors today.

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.

AltaGas has a rather high debt to EBITDA ratio of 5.8 which suggests a meaningful debt load. But the good news is that it boasts fairly comforting interest cover of 2.6 times, suggesting it can responsibly service its obligations. More concerning, AltaGas saw its EBIT drop by 7.5% in the last twelve months. If it keeps going like that paying off its debt will be like running on a treadmill -- a lot of effort for not much advancement. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine AltaGas'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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Over the last three years, AltaGas recorded negative free cash flow, in total. Debt is far more risky for companies with unreliable free cash flow, so shareholders should be hoping that the past expenditure will produce free cash flow in the future.

Our View

To be frank both AltaGas's net debt to EBITDA and its track record of staying on top of its total liabilities make us rather uncomfortable with its debt levels. And even its interest cover fails to inspire much confidence. It's also worth noting that AltaGas is in the Gas Utilities industry, which is often considered to be quite defensive. After considering the datapoints discussed, we think AltaGas has too much debt. That sort of riskiness is ok for some, but it certainly doesn't float our boat. 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. To that end, you should learn about the 4 warning signs we've spotted with AltaGas (including 2 which are a bit unpleasant) .

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.