We Think OGE Energy (NYSE:OGE) Is Taking Some Risk With Its Debt

By
Simply Wall St
Published
March 02, 2021
NYSE:OGE

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.' 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. We note that OGE Energy Corp. (NYSE:OGE) does have debt on its balance sheet. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

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 usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for OGE Energy

What Is OGE Energy's Net Debt?

The image below, which you can click on for greater detail, shows that at December 2020 OGE Energy had debt of US$3.59b, up from US$3.31b in one year. And it doesn't have much cash, so its net debt is about the same.

debt-equity-history-analysis
NYSE:OGE Debt to Equity History March 2nd 2021

How Strong Is OGE Energy's Balance Sheet?

The latest balance sheet data shows that OGE Energy had liabilities of US$697.4m due within a year, and liabilities of US$6.39b falling due after that. Offsetting these obligations, it had cash of US$1.10m as well as receivables valued at US$233.5m due within 12 months. So its liabilities total US$6.85b more than the combination of its cash and short-term receivables.

When you consider that this deficiency exceeds the company's US$5.92b market capitalization, you might well be inclined to review the balance sheet intently. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer extensive 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).

OGE Energy's debt is 4.0 times its EBITDA, and its EBIT cover its interest expense 3.2 times over. This suggests that while the debt levels are significant, we'd stop short of calling them problematic. The good news is that OGE Energy improved its EBIT by 3.0% over the last twelve months, thus gradually reducing its debt levels relative to its earnings. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine OGE 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 the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. In the last three years, OGE Energy's free cash flow amounted to 32% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Our View

On the face of it, OGE Energy's net debt to EBITDA left us tentative about the stock, and its level of total liabilities was no more enticing than the one empty restaurant on the busiest night of the year. But at least its EBIT growth rate is not so bad. It's also worth noting that OGE Energy is in the Electric Utilities industry, which is often considered to be quite defensive. Overall, we think it's fair to say that OGE Energy has enough debt that there are some real risks around the balance sheet. If all goes well, that should boost returns, but on the flip side, the risk of permanent capital loss is elevated by the debt. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 2 warning signs for OGE Energy (1 is significant!) that you should be aware of before investing here.

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.

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This article by Simply Wall St is general in nature. 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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