Health Check: How Prudently Does TransAlta (TSE:TA) Use Debt?

By
Simply Wall St
Published
March 08, 2021
TSX:TA
Source: Shutterstock

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.' 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. We can see that TransAlta Corporation (TSE:TA) does use debt in its business. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

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. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for TransAlta

How Much Debt Does TransAlta Carry?

As you can see below, at the end of December 2020, TransAlta had CA$3.96b of debt, up from CA$3.40b a year ago. Click the image for more detail. However, it also had CA$703.0m in cash, and so its net debt is CA$3.25b.

debt-equity-history-analysis
TSX:TA Debt to Equity History March 8th 2021

How Healthy Is TransAlta's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that TransAlta had liabilities of CA$935.0m due within 12 months and liabilities of CA$5.38b due beyond that. Offsetting these obligations, it had cash of CA$703.0m as well as receivables valued at CA$534.0m due within 12 months. So its liabilities total CA$5.07b more than the combination of its cash and short-term receivables.

This deficit casts a shadow over the CA$2.78b 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, TransAlta would probably need a major re-capitalization if its creditors were to demand repayment. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine TransAlta'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.

In the last year TransAlta had a loss before interest and tax, and actually shrunk its revenue by 10%, to CA$2.1b. We would much prefer see growth.

Caveat Emptor

While TransAlta's falling revenue is about as heartwarming as a wet blanket, arguably its earnings before interest and tax (EBIT) loss is even less appealing. Indeed, it lost CA$15m at the EBIT level. When we look at that alongside the significant liabilities, we're not particularly confident about the company. We'd want to see some strong near-term improvements before getting too interested in the stock. For example, we would not want to see a repeat of last year's loss of CA$336m. In the meantime, we consider the stock to be risky. 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. We've identified 2 warning signs with TransAlta (at least 1 which is potentially serious) , and understanding them should be part of your investment process.

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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