Canadian Utilities (TSE:CU) Use Of Debt Could Be Considered Risky

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.' 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. As with many other companies Canadian Utilities Limited (TSE:CU) makes use of debt. But the real question is whether this debt is making the company risky.

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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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

What Is Canadian Utilities's Debt?

The image below, which you can click on for greater detail, shows that at December 2024 Canadian Utilities had debt of CA$11.1b, up from CA$10.5b in one year. However, because it has a cash reserve of CA$397.0m, its net debt is less, at about CA$10.7b.

How Healthy Is Canadian Utilities' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Canadian Utilities had liabilities of CA$1.18b due within 12 months and liabilities of CA$15.5b due beyond that. Offsetting these obligations, it had cash of CA$397.0m as well as receivables valued at CA$763.0m due within 12 months. So its liabilities total CA$15.5b more than the combination of its cash and short-term receivables.

This deficit casts a shadow over the CA$9.95b company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. At the end of the day, Canadian Utilities would probably need a major re-capitalization if its creditors were to demand repayment.

Check out our latest analysis for Canadian Utilities

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.

Weak interest cover of 2.2 times and a disturbingly high net debt to EBITDA ratio of 6.4 hit our confidence in Canadian Utilities like a one-two punch to the gut. This means we'd consider it to have a heavy debt load. More concerning, Canadian Utilities 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. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Canadian 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, a company can only pay off debt with cold hard cash, not accounting profits. So we always check how much of that EBIT is translated into free cash flow. In the last three years, Canadian Utilities's free cash flow amounted to 47% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Our View

To be frank both Canadian Utilities's level of total liabilities and its track record of managing its debt, based on its EBITDA, make us rather uncomfortable with its debt levels. Having said that, its ability to convert EBIT to free cash flow isn't such a worry. It's also worth noting that Canadian Utilities is in the Integrated Utilities industry, which is often considered to be quite defensive. Overall, it seems to us that Canadian Utilities's balance sheet is really quite a risk to the business. For this reason we're pretty cautious about the stock, and we think shareholders should keep a close eye on its liquidity. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should learn about the 4 warning signs we've spotted with Canadian Utilities (including 3 which can't be ignored) .

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.