Does Algonquin Power & Utilities (TSE:AQN) Have A Healthy Balance Sheet?

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We can see that Algonquin Power & Utilities Corp. (TSE:AQN) does use debt in its business. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

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, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Algonquin Power & Utilities

How Much Debt Does Algonquin Power & Utilities Carry?

As you can see below, at the end of September 2022, Algonquin Power & Utilities had US$7.77b of debt, up from US$6.95b a year ago. Click the image for more detail. And it doesn't have much cash, so its net debt is about the same.

How Strong Is Algonquin Power & Utilities' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Algonquin Power & Utilities had liabilities of US$1.49b due within 12 months and liabilities of US$9.10b due beyond that. Offsetting these obligations, it had cash of US$114.3m as well as receivables valued at US$432.6m due within 12 months. So its liabilities total US$10.0b more than the combination of its cash and short-term receivables.

This deficit casts a shadow over the US$5.05b company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. After all, Algonquin Power & Utilities 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.

Algonquin Power & Utilities shareholders face the double whammy of a high net debt to EBITDA ratio (8.4), and fairly weak interest coverage, since EBIT is just 1.9 times the interest expense. The debt burden here is substantial. On a lighter note, we note that Algonquin Power & Utilities 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 Algonquin Power & Utilities 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.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. During the last three years, Algonquin Power & Utilities burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

To be frank both Algonquin Power & Utilities's conversion of EBIT to free cash flow and its track record of staying on top of its total liabilities make us rather uncomfortable with its debt levels. But at least it's pretty decent at growing its EBIT; that's encouraging. We should also note that Integrated Utilities industry companies like Algonquin Power & Utilities commonly do use debt without problems. Overall, it seems to us that Algonquin Power & Utilities's balance sheet is really quite a risk to the business. So we're almost as wary of this stock as a hungry kitten is about falling into its owner's fish pond: once bitten, twice shy, as they say. 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 Algonquin Power & Utilities has 4 warning signs (and 2 which are a bit concerning) we think you should know about.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.