These 4 Measures Indicate That CGE Gas Natural (SNSE:CGEGAS) Is Using Debt Reasonably Well

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' 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. Importantly, CGE Gas Natural S.A. (SNSE:CGEGAS) does carry debt. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

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. If things get really bad, the lenders can take control of the business. 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. 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.

See our latest analysis for CGE Gas Natural

What Is CGE Gas Natural's Net Debt?

As you can see below, at the end of December 2020, CGE Gas Natural had CL$441.9b of debt, up from CL$420.6b a year ago. Click the image for more detail. On the flip side, it has CL$121.9b in cash leading to net debt of about CL$320.0b.

A Look At CGE Gas Natural's Liabilities

The latest balance sheet data shows that CGE Gas Natural had liabilities of CL$180.4b due within a year, and liabilities of CL$749.7b falling due after that. Offsetting this, it had CL$121.9b in cash and CL$48.0b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CL$760.1b.

When you consider that this deficiency exceeds the company's CL$671.7b market capitalization, you might well be inclined to review the balance sheet intently. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price.

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).

CGE Gas Natural's net debt of 1.7 times EBITDA suggests graceful use of debt. And the alluring interest cover (EBIT of 9.4 times interest expense) certainly does not do anything to dispel this impression. The good news is that CGE Gas Natural has increased its EBIT by 3.2% over twelve months, which should ease any concerns about debt repayment. When analysing debt levels, the balance sheet is the obvious place to start. But it is CGE Gas Natural's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

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 70% 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. But truth be told its level of total liabilities had us nibbling our nails. We would also note that Gas Utilities industry companies like CGE Gas Natural commonly do use debt without problems. When we consider all the factors mentioned above, we do feel a bit cautious about CGE Gas Natural's use of debt. 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. 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. Case in point: We've spotted 3 warning signs for CGE Gas Natural you should be aware of, and 1 of them is concerning.

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. 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.
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