Is S.N.T.G.N. Transgaz (BVB:TGN) A Risky Investment?

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says '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 real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. 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. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first step when considering a company's debt levels is to consider its 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?

You can click the graphic below for the historical numbers, but it shows that as of September 2024 S.N.T.G.N. Transgaz had RON2.87b of debt, an increase on RON2.51b, over one year. However, it does have RON677.5m in cash offsetting this, leading to net debt of about RON2.20b.

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

According to the last reported balance sheet, S.N.T.G.N. Transgaz had liabilities of RON1.60b due within 12 months, and liabilities of RON3.83b due beyond 12 months. On the other hand, it had cash of RON677.5m and RON356.2m worth of receivables due within a year. So it has liabilities totalling RON4.39b more than its cash and near-term receivables, combined.

This deficit is considerable relative to its market capitalization of RON4.80b, 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.

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). 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's net debt is 2.9 times its EBITDA, which is a significant but still reasonable amount of leverage. However, its interest coverage of 1k is very high, suggesting that the interest expense on the debt is currently quite low. We also note that S.N.T.G.N. Transgaz improved its EBIT from a last year's loss to a positive RON269m. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since S.N.T.G.N. Transgaz will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So it is important to check how much of its earnings before interest and tax (EBIT) converts to actual free cash flow. Over the last year, 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

Mulling over S.N.T.G.N. Transgaz's attempt at converting EBIT to free cash flow, we're certainly not enthusiastic. But on the bright side, its interest cover is a good sign, and makes us more optimistic. It's also worth noting that S.N.T.G.N. Transgaz is in the Gas Utilities industry, which is often considered to be quite defensive. Once we consider all the factors above, together, it seems to us that S.N.T.G.N. Transgaz's debt is making it a bit risky. That's not necessarily a bad thing, but we'd generally feel more comfortable with less leverage. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 2 warning signs for S.N.T.G.N. Transgaz (1 is potentially serious) you should be aware of.

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.