Is CGE Gas Natural (SNSE:CGEGAS) Using Too Much 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.' 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 CGE Gas Natural S.A. (SNSE:CGEGAS) makes use of debt. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for CGE Gas Natural

How Much Debt Does CGE Gas Natural Carry?

The image below, which you can click on for greater detail, shows that CGE Gas Natural had debt of CL$456.3b at the end of September 2021, a reduction from CL$480.7b over a year. However, because it has a cash reserve of CL$113.8b, its net debt is less, at about CL$342.5b.

How Healthy Is CGE Gas Natural's Balance Sheet?

We can see from the most recent balance sheet that CGE Gas Natural had liabilities of CL$133.8b falling due within a year, and liabilities of CL$800.2b due beyond that. On the other hand, it had cash of CL$113.8b and CL$107.4b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by CL$712.9b.

When you consider that this deficiency exceeds the company's CL$561.2b market capitalization, you might well be inclined to review the balance sheet intently. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer extensive dilution.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). 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).

CGE Gas Natural's net debt to EBITDA ratio of about 1.9 suggests only moderate use of debt. And its strong interest cover of 10.7 times, makes us even more comfortable. Notably CGE Gas Natural's EBIT was pretty flat over the last year. Ideally it can diminish its debt load by kick-starting earnings growth. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since CGE Gas Natural will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

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, CGE Gas Natural produced sturdy free cash flow equating to 79% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Our View

CGE Gas Natural's conversion of EBIT to free cash flow was a real positive on this analysis, as was its interest cover. In contrast, our confidence was undermined by its apparent struggle to handle its total liabilities. We would also note that Gas Utilities industry companies like CGE Gas Natural commonly do use debt without problems. Looking at all this data makes us feel a little cautious about CGE Gas Natural's debt levels. While debt does have its upside in higher potential returns, we think shareholders should definitely consider how debt levels might make the stock more risky. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. To that end, you should learn about the 3 warning signs we've spotted with CGE Gas Natural (including 1 which is a bit concerning) .

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.