These 4 Measures Indicate That Adani Total Gas (NSE:ATGL) Is Using Debt Reasonably Well

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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 should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Adani Total Gas

What Is Adani Total Gas's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of March 2021 Adani Total Gas had ₹5.29b of debt, an increase on ₹4.28b, over one year. And it doesn't have much cash, so its net debt is about the same.

How Strong Is Adani Total Gas' Balance Sheet?

We can see from the most recent balance sheet that Adani Total Gas had liabilities of ₹8.08b falling due within a year, and liabilities of ₹4.62b due beyond that. Offsetting this, it had ₹102.6m in cash and ₹1.35b in receivables that were due within 12 months. So it has liabilities totalling ₹11.2b more than its cash and near-term receivables, combined.

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 ₹1.24t 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.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Adani Total Gas's net debt is only 0.63 times its EBITDA. And its EBIT easily covers its interest expense, being 65.4 times the size. So we're pretty relaxed about its super-conservative use of debt. In addition to that, we're happy to report that Adani Total Gas has boosted its EBIT by 58%, thus reducing the spectre of future debt repayments. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Adani Total Gas can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. Over the last three years, Adani Total Gas reported free cash flow worth 13% of its EBIT, which is really quite low. That limp level of cash conversion undermines its ability to manage and pay down debt.

Our View

Adani Total Gas's interest cover suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. But, on a more sombre note, we are a little concerned by its conversion of EBIT to free cash flow. 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. While debt does bring risk, when used wisely it can also bring a higher return on equity. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. These risks can be hard to spot. Every company has them, and we've spotted 1 warning sign for Adani Total Gas you should know about.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.
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