Here's Why ONE Gas (NYSE:OGS) Is Weighed Down By Its Debt Load

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. Importantly, ONE Gas, Inc. (NYSE:OGS) does carry debt. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. If things get really bad, the lenders can take control of the business. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

Our analysis indicates that OGS is potentially undervalued!

What Is ONE Gas's Net Debt?

The chart below, which you can click on for greater detail, shows that ONE Gas had US$4.17b in debt in June 2022; about the same as the year before. And it doesn't have much cash, so its net debt is about the same.

A Look At ONE Gas' Liabilities

According to the last reported balance sheet, ONE Gas had liabilities of US$2.33b due within 12 months, and liabilities of US$3.63b due beyond 12 months. Offsetting these obligations, it had cash of US$7.39m as well as receivables valued at US$242.7m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$5.71b.

This deficit casts a shadow over the US$3.79b company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. After all, ONE Gas would likely require a major re-capitalisation if it had to pay its creditors today.

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

ONE Gas has a rather high debt to EBITDA ratio of 7.7 which suggests a meaningful debt load. But the good news is that it boasts fairly comforting interest cover of 5.3 times, suggesting it can responsibly service its obligations. We saw ONE Gas grow its EBIT by 8.0% in the last twelve months. That's far from incredible but it is a good thing, when it comes to paying off debt. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if ONE 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 it's worth checking how much of that EBIT is backed by free cash flow. Over the last three years, ONE Gas 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

To be frank both ONE Gas's net debt to EBITDA and its track record of converting EBIT to free cash flow make us rather uncomfortable with its debt levels. But at least it's pretty decent at growing its EBIT; that's encouraging. We should also note that Gas Utilities industry companies like ONE Gas commonly do use debt without problems. Overall, it seems to us that ONE Gas's balance sheet is really quite a risk to the business. For this reason we're pretty cautious about the stock, and we think shareholders should keep a close eye on its liquidity. 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. These risks can be hard to spot. Every company has them, and we've spotted 3 warning signs for ONE Gas (of which 1 is significant!) you should know about.

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.