Adani Total Gas (NSE:ATGL) Has A Pretty Healthy Balance Sheet

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.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We note that Adani Total Gas Limited (NSE:ATGL) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

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. If things get really bad, the lenders can take control of the business. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Adani Total Gas

What Is Adani Total Gas's Net Debt?

As you can see below, at the end of March 2023, Adani Total Gas had ₹13.7b of debt, up from ₹9.95b a year ago. Click the image for more detail. However, because it has a cash reserve of ₹521.8m, its net debt is less, at about ₹13.2b.

How Healthy Is Adani Total Gas' Balance Sheet?

According to the last reported balance sheet, Adani Total Gas had liabilities of ₹21.9b due within 12 months, and liabilities of ₹5.11b due beyond 12 months. Offsetting this, it had ₹521.8m in cash and ₹3.24b in receivables that were due within 12 months. So its liabilities total ₹23.3b more than the combination of its cash and short-term receivables.

Of course, Adani Total Gas has a market capitalization of ₹703.9b, so these liabilities are probably manageable. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time.

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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Adani Total Gas's net debt to EBITDA ratio of about 1.5 suggests only moderate use of debt. And its commanding EBIT of 29.2 times its interest expense, implies the debt load is as light as a peacock feather. The good news is that Adani Total Gas has increased its EBIT by 9.6% over twelve months, which should ease any concerns about debt repayment. There's no doubt that we learn most about debt from the balance sheet. But it is Adani Total Gas'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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. During the last three years, Adani Total Gas burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

Based on what we've seen Adani Total Gas is not finding it easy, given its conversion of EBIT to free cash flow, but the other factors we considered give us cause to be optimistic. There's no doubt that its ability to to cover its interest expense with its EBIT is pretty flash. We would also note that Gas Utilities industry companies like Adani Total Gas commonly do use debt without problems. When we consider all the elements mentioned above, it seems to us that Adani Total Gas is managing its debt quite well. But a word of caution: we think debt levels are high enough to justify ongoing monitoring. 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. For example, we've discovered 2 warning signs for Adani Total Gas (1 is concerning!) that you should be aware of before investing here.

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.