Is National Fuel Gas (NYSE:NFG) A Risky Investment?

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. Importantly, National Fuel Gas Company (NYSE:NFG) does carry debt. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

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. If things get really bad, the lenders can take control of the business. 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.

View our latest analysis for National Fuel Gas

How Much Debt Does National Fuel Gas Carry?

As you can see below, National Fuel Gas had US$2.73b of debt, at December 2022, which is about the same as the year before. You can click the chart for greater detail. However, because it has a cash reserve of US$244.5m, its net debt is less, at about US$2.49b.

A Look At National Fuel Gas' Liabilities

The latest balance sheet data shows that National Fuel Gas had liabilities of US$1.54b due within a year, and liabilities of US$4.06b falling due after that. Offsetting these obligations, it had cash of US$244.5m as well as receivables valued at US$425.1m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$4.93b.

This is a mountain of leverage relative to its market capitalization of US$5.28b. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.

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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

National Fuel Gas's net debt is sitting at a very reasonable 2.0 times its EBITDA, while its EBIT covered its interest expense just 6.4 times last year. While that doesn't worry us too much, it does suggest the interest payments are somewhat of a burden. Also relevant is that National Fuel Gas has grown its EBIT by a very respectable 23% 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 ultimately the future profitability of the business will decide if National Fuel Gas 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. So we always check how much of that EBIT is translated into free cash flow. Considering the last three years, National Fuel Gas actually recorded a cash outflow, overall. Debt is usually more expensive, and almost always more risky in the hands of a company with negative free cash flow. Shareholders ought to hope for an improvement.

Our View

National Fuel Gas'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. In particular, its EBIT growth rate was re-invigorating. We should also note that Gas Utilities industry companies like National Fuel Gas commonly do use debt without problems. When we consider all the factors discussed, it seems to us that National Fuel Gas 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 2 warning signs with National Fuel Gas , and understanding them should be part of your investment process.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.