Stock Analysis

Here's Why TGS (OB:TGS) Can Manage Its Debt Responsibly

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Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a 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. We can see that TGS ASA (OB:TGS) does use debt in its business. But is this debt a concern to shareholders?

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 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for TGS

What Is TGS's Net Debt?

As you can see below, at the end of December 2022, TGS had US$44.7m of debt, up from none a year ago. Click the image for more detail. But on the other hand it also has US$188.5m in cash, leading to a US$143.7m net cash position.

OB:TGS Debt to Equity History March 31st 2023

How Strong Is TGS' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that TGS had liabilities of US$505.0m due within 12 months and liabilities of US$144.1m due beyond that. On the other hand, it had cash of US$188.5m and US$240.3m worth of receivables due within a year. So it has liabilities totalling US$220.3m more than its cash and near-term receivables, combined.

Since publicly traded TGS shares are worth a total of US$2.23b, it seems unlikely that this level of liabilities would be a major threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. Despite its noteworthy liabilities, TGS boasts net cash, so it's fair to say it does not have a heavy debt load!

On top of that, TGS grew its EBIT by 65% 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 ultimately the future profitability of the business will decide if TGS can strengthen its balance sheet over time. 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. TGS may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Looking at the most recent two years, TGS recorded free cash flow of 44% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing Up

We could understand if investors are concerned about TGS's liabilities, but we can be reassured by the fact it has has net cash of US$143.7m. And it impressed us with its EBIT growth of 65% over the last year. So is TGS's debt a risk? It doesn't seem so to us. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. Be aware that TGS is showing 2 warning signs in our investment analysis , you should know about...

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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