Does S.N.T.G.N. Transgaz (BVB:TGN) Have A Healthy Balance Sheet?

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. As with many other companies S.N.T.G.N. Transgaz S.A. (BVB:TGN) makes use of debt. But the more important question is: how much risk is that debt creating?

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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for S.N.T.G.N. Transgaz

What Is S.N.T.G.N. Transgaz's Net Debt?

As you can see below, at the end of March 2021, S.N.T.G.N. Transgaz had RON1.73b of debt, up from RON668.5m a year ago. Click the image for more detail. However, it does have RON329.9m in cash offsetting this, leading to net debt of about RON1.40b.

A Look At S.N.T.G.N. Transgaz's Liabilities

We can see from the most recent balance sheet that S.N.T.G.N. Transgaz had liabilities of RON575.9m falling due within a year, and liabilities of RON2.82b due beyond that. On the other hand, it had cash of RON329.9m and RON616.8m worth of receivables due within a year. So it has liabilities totalling RON2.45b more than its cash and near-term receivables, combined.

This deficit is considerable relative to its market capitalization of RON3.40b, so it does suggest shareholders should keep an eye on S.N.T.G.N. Transgaz's use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.

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).

S.N.T.G.N. Transgaz has a debt to EBITDA ratio of 4.1, which signals significant debt, but is still pretty reasonable for most types of business. However, its interest coverage of 1k is very high, suggesting that the interest expense on the debt is currently quite low. Shareholders should be aware that S.N.T.G.N. Transgaz's EBIT was down 77% last year. If that earnings trend continues then paying off its debt will be about as easy as herding cats on to a roller coaster. 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 S.N.T.G.N. Transgaz's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the last three years, S.N.T.G.N. Transgaz saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

To be frank both S.N.T.G.N. Transgaz's conversion of EBIT to free cash flow and its track record of (not) growing its EBIT make us rather uncomfortable with its debt levels. But at least it's pretty decent at covering its interest expense with its EBIT; that's encouraging. Overall, it seems to us that S.N.T.G.N. Transgaz's balance sheet is really quite a risk to the business. For this reason we're pretty cautious about the stock, and we think shareholders should keep a close eye on its liquidity. 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. These risks can be hard to spot. Every company has them, and we've spotted 4 warning signs for S.N.T.G.N. Transgaz (of which 3 are a bit unpleasant!) 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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