These 4 Measures Indicate That Algonquin Power & Utilities (TSE:AQN) Is Using Debt Extensively

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. Importantly, Algonquin Power & Utilities Corp. (TSE:AQN) 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. 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, 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.

See our latest analysis for Algonquin Power & Utilities

What Is Algonquin Power & Utilities's Debt?

As you can see below, at the end of March 2023, Algonquin Power & Utilities had US$7.90b of debt, up from US$7.19b a year ago. Click the image for more detail. And it doesn't have much cash, so its net debt is about the same.

A Look At Algonquin Power & Utilities' Liabilities

Zooming in on the latest balance sheet data, we can see that Algonquin Power & Utilities had liabilities of US$1.39b due within 12 months and liabilities of US$9.16b due beyond that. Offsetting these obligations, it had cash of US$61.0m as well as receivables valued at US$514.3m due within 12 months. So its liabilities total US$9.98b more than the combination of its cash and short-term receivables.

This deficit casts a shadow over the US$5.35b 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.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Weak interest cover of 1.6 times and a disturbingly high net debt to EBITDA ratio of 8.2 hit our confidence in Algonquin Power & Utilities like a one-two punch to the gut. The debt burden here is substantial. On a slightly more positive note, Algonquin Power & Utilities grew its EBIT at 20% over the last year, further increasing its ability to manage 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 Algonquin Power & Utilities 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 it's worth checking how much of that EBIT is backed by free cash flow. During the last three years, Algonquin Power & Utilities burned a lot of cash. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is 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 on the bright side, its EBIT growth rate is a good sign, and makes us more optimistic. It's also worth noting that Algonquin Power & Utilities is in the Integrated Utilities industry, which is often considered to be quite defensive. After considering the datapoints discussed, we think Algonquin Power & Utilities 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. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 2 warning signs for Algonquin Power & Utilities you should be aware of.

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.