Adani Total Gas (NSE:ATGL) Seems To Use Debt Quite Sensibly

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.' 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 note that Adani Total Gas Limited (NSE:ATGL) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

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. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Adani Total Gas

How Much Debt Does Adani Total Gas Carry?

You can click the graphic below for the historical numbers, but it shows that as of March 2022 Adani Total Gas had ₹10.4b of debt, an increase on ₹5.29b, over one year. On the flip side, it has ₹312.7m in cash leading to net debt of about ₹10.0b.

A Look At Adani Total Gas' Liabilities

Zooming in on the latest balance sheet data, we can see that Adani Total Gas had liabilities of ₹14.6b due within 12 months and liabilities of ₹5.35b due beyond that. Offsetting these obligations, it had cash of ₹312.7m as well as receivables valued at ₹2.23b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₹17.4b.

Having regard to Adani Total Gas' size, it seems that its liquid assets are well balanced with its total liabilities. So while it's hard to imagine that the ₹3.99t company is struggling for cash, we still think it's worth monitoring its balance sheet. But either way, Adani Total Gas has virtually no net debt, so it's fair to say it does not have a heavy debt load!

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 is only 1.3 times its EBITDA. And its EBIT easily covers its interest expense, being 25.4 times the size. So you could argue it is no more threatened by its debt than an elephant is by a mouse. On the other hand, Adani Total Gas saw its EBIT drop by 9.1% in the last twelve months. That sort of decline, if sustained, will obviously make debt harder to handle. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Adani Total Gas 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, 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. Over the last three years, Adani Total Gas recorded negative free cash flow, in total. Debt is far more risky for companies with unreliable free cash flow, so shareholders should be hoping that the past expenditure will produce free cash flow in the future.

Our View

On our analysis Adani Total Gas's interest cover should signal that it won't have too much trouble with its debt. But the other factors we noted above weren't so encouraging. To be specific, it seems about as good at converting EBIT to free cash flow as wet socks are at keeping your feet warm. It's also worth noting that Adani Total Gas is in the Gas Utilities industry, which is often considered to be quite defensive. Looking at all this data makes us feel a little cautious about Adani Total Gas'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. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 3 warning signs for Adani Total Gas you should be aware of.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.