Is MGE Energy (NASDAQ:MGEE) Using Too Much Debt?

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. Importantly, MGE Energy, Inc. (NASDAQ:MGEE) does carry debt. But the real question is whether this debt is making the company risky.

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for MGE Energy

How Much Debt Does MGE Energy Carry?

The image below, which you can click on for greater detail, shows that at June 2021 MGE Energy had debt of US$592.3m, up from US$541.2m in one year. However, it does have US$34.0m in cash offsetting this, leading to net debt of about US$558.2m.

A Look At MGE Energy's Liabilities

We can see from the most recent balance sheet that MGE Energy had liabilities of US$145.7m falling due within a year, and liabilities of US$1.15b due beyond that. Offsetting this, it had US$34.0m in cash and US$72.0m in receivables that were due within 12 months. So its liabilities total US$1.19b more than the combination of its cash and short-term receivables.

This deficit isn't so bad because MGE Energy is worth US$2.69b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.

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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

MGE Energy's debt is 2.7 times its EBITDA, and its EBIT cover its interest expense 5.8 times over. This suggests that while the debt levels are significant, we'd stop short of calling them problematic. One way MGE Energy could vanquish its debt would be if it stops borrowing more but continues to grow EBIT at around 10%, as it did over the last year. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if MGE Energy 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we always check how much of that EBIT is translated into free cash flow. During the last three years, MGE Energy burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

MGE Energy's struggle to convert EBIT to free cash flow had us second guessing its balance sheet strength, but the other data-points we considered were relatively redeeming. But on the bright side, its ability to to grow its EBIT isn't too shabby at all. We should also note that Electric Utilities industry companies like MGE Energy commonly do use debt without problems. When we consider all the factors discussed, it seems to us that MGE Energy is taking some risks with its use of debt. So while that leverage does boost returns on equity, we wouldn't really want to see it increase from here. 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. We've identified 1 warning sign with MGE Energy , and understanding them should be part of your investment process.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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