Here's Why Adani Total Gas (NSE:ATGL) Can Manage Its Debt Responsibly

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 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?

When Is Debt A Problem?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. If things get really bad, the lenders can take control of the business. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Adani Total Gas

How Much Debt Does Adani Total Gas Carry?

The image below, which you can click on for greater detail, shows that at September 2021 Adani Total Gas had debt of ₹6.30b, up from ₹3.73b in one year. However, it does have ₹298.6m in cash offsetting this, leading to net debt of about ₹6.00b.

A Look At Adani Total Gas' Liabilities

The latest balance sheet data shows that Adani Total Gas had liabilities of ₹10.8b due within a year, and liabilities of ₹4.38b falling due after that. Offsetting these obligations, it had cash of ₹298.6m as well as receivables valued at ₹1.25b due within 12 months. So its liabilities total ₹13.6b more than the combination of its cash and short-term receivables.

This state of affairs indicates that Adani Total Gas' balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So while it's hard to imagine that the ₹2.01t company is struggling for cash, we still think it's worth monitoring its balance sheet. Carrying virtually no net debt, Adani Total Gas has a very light debt load indeed.

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 0.71 times its EBITDA. And its EBIT easily covers its interest expense, being 54.9 times the size. So you could argue it is no more threatened by its debt than an elephant is by a mouse. On top of that, Adani Total Gas grew its EBIT by 41% over the last twelve months, and that growth will make it easier to handle its debt. 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 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 clearly need to look at whether that EBIT is leading to corresponding free cash flow. In the last three years, Adani Total Gas created free cash flow amounting to 12% of its EBIT, an uninspiring performance. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.

Our View

The good news is that Adani Total Gas's demonstrated ability to cover its interest expense with its EBIT delights us like a fluffy puppy does a toddler. But we must concede we find its conversion of EBIT to free cash flow has the opposite effect. It's also worth noting that Adani Total Gas is in the Gas Utilities industry, which is often considered to be quite defensive. Zooming out, Adani Total Gas seems to use debt quite reasonably; and that gets the nod from us. After all, sensible leverage can boost returns on equity. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should learn about the 2 warning signs we've spotted with Adani Total Gas (including 1 which is a bit unpleasant) .

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.