These 4 Measures Indicate That Atmos Energy (NYSE:ATO) Is Using Debt Extensively

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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We note that Atmos Energy Corporation (NYSE:ATO) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. 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. 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.

View our latest analysis for Atmos Energy

What Is Atmos Energy's Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2024 Atmos Energy had US$7.82b of debt, an increase on US$6.84b, over one year. However, because it has a cash reserve of US$307.3m, its net debt is less, at about US$7.51b.

How Healthy Is Atmos Energy's Balance Sheet?

According to the last reported balance sheet, Atmos Energy had liabilities of US$1.21b due within 12 months, and liabilities of US$11.8b due beyond 12 months. On the other hand, it had cash of US$307.3m and US$380.2m worth of receivables due within a year. So it has liabilities totalling US$12.3b more than its cash and near-term receivables, combined.

While this might seem like a lot, it is not so bad since Atmos Energy has a huge market capitalization of US$23.3b, and so it could probably strengthen its balance sheet by raising capital if it needed to. However, it is still worthwhile taking a close look at its ability to pay off debt.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Atmos Energy has net debt to EBITDA of 3.7 suggesting it uses a fair bit of leverage to boost returns. On the plus side, its EBIT was 8.0 times its interest expense, and its net debt to EBITDA, was quite high, at 3.7. Also relevant is that Atmos Energy has grown its EBIT by a very respectable 27% in the last year, thus enhancing its ability to pay down debt. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Atmos Energy'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 company can only pay off debt with cold hard cash, not accounting profits. So we always check how much of that EBIT is translated into free cash flow. Over the last three years, Atmos Energy saw substantial negative free cash flow, in total. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Our View

Atmos Energy's conversion of EBIT to free cash flow was a real negative on this analysis, although the other factors we considered cast it in a significantly better light. For example its EBIT growth rate was refreshing. We should also note that Gas Utilities industry companies like Atmos Energy commonly do use debt without problems. Looking at all the angles mentioned above, it does seem to us that Atmos Energy is a somewhat risky investment as a result of its debt. Not all risk is bad, as it can boost share price returns if it pays off, but this debt risk is worth keeping in mind. 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. For example, we've discovered 3 warning signs for Atmos Energy that you should be aware of before investing here.

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.