Here's Why Avance Gas Holding (OB:AGAS) Has A Meaningful Debt Burden

By
Simply Wall St
Published
August 23, 2021
OB:AGAS
Source: Shutterstock

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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. As with many other companies Avance Gas Holding Ltd (OB:AGAS) makes use of debt. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. 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. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Avance Gas Holding

What Is Avance Gas Holding's Debt?

As you can see below, Avance Gas Holding had US$368.1m of debt at June 2021, down from US$471.8m a year prior. However, it does have US$107.9m in cash offsetting this, leading to net debt of about US$260.2m.

debt-equity-history-analysis
OB:AGAS Debt to Equity History August 24th 2021

How Healthy Is Avance Gas Holding's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Avance Gas Holding had liabilities of US$59.3m due within 12 months and liabilities of US$362.0m due beyond that. Offsetting these obligations, it had cash of US$107.9m as well as receivables valued at US$20.6m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$292.7m.

This is a mountain of leverage relative to its market capitalization of US$384.0m. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry.

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).

Avance Gas Holding has a debt to EBITDA ratio of 2.9 and its EBIT covered its interest expense 2.6 times. This suggests that while the debt levels are significant, we'd stop short of calling them problematic. Even worse, Avance Gas Holding saw its EBIT tank 55% over the last 12 months. If earnings keep going like that over the long term, it has a snowball's chance in hell of paying off that debt. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Avance Gas Holding's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So we always check how much of that EBIT is translated into free cash flow. Over the most recent three years, Avance Gas Holding recorded free cash flow worth 64% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Our View

Mulling over Avance Gas Holding's attempt at (not) growing its EBIT, we're certainly not enthusiastic. But at least it's pretty decent at converting EBIT to free cash flow; that's encouraging. Overall, we think it's fair to say that Avance Gas Holding has enough debt that there are some real risks around the balance sheet. If all goes well, that should boost returns, but on the flip side, the risk of permanent capital loss is elevated by the debt. 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. Be aware that Avance Gas Holding is showing 4 warning signs in our investment analysis , and 2 of those make us uncomfortable...

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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