Atmos Energy (NYSE: ATO) takes risks with its use of debt
David Iben put it well when he said: “Volatility is not a risk we care about. What matters to us is to avoid the permanent loss of capital. ‘ When we think about how risky a business is, we always like to look at its use of debt because debt overload can lead to bankruptcy. Like many other companies Atmos energy company (NYSE: ATO) uses debt. But the real question is whether this debt makes the business risky.
When Is Debt a Problem?
Generally speaking, debt only becomes a real problem when a company cannot repay it easily, either by raising capital or with its own cash flow. If things really go wrong, lenders can take over the business. However, a more common (but still costly) situation is where a company has to dilute its shareholders at a cheap share price just to get its debt under control. Of course, many companies use debt to finance their growth without negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash flow and debt together.
Check out our latest review for Atmos Energy
What is Atmos Energy’s debt?
The image below, which you can click for more details, shows that in March 2021 Atmos Energy was in debt of $ 7.31 billion, compared to $ 4.52 billion in a year. However, he also had $ 997.1 million in cash, so his net debt is $ 6.31 billion.
How strong is Atmos Energy’s balance sheet?
According to the latest published balance sheet, Atmos Energy had liabilities of US $ 871.3 million due within 12 months and liabilities of US $ 10.7 billion due beyond 12 months. On the other hand, it had US $ 997.1 million in cash and US $ 469.6 million in receivables due within a year. It therefore has liabilities totaling US $ 10.1 billion more than its cash and short-term receivables combined.
That’s a mountain of leverage even compared to its gargantuan market cap of US $ 13.2 billion. This suggests that shareholders would be heavily diluted if the company needed to consolidate its balance sheet quickly.
We measure a company’s debt load relative to its earning capacity by looking at its net debt divided by its earnings before interest, taxes, depreciation, and amortization (EBITDA) and calculating how easily its earnings before interest and taxes (EBIT) covers its interest costs (interest coverage). In this way, we consider both the absolute amount of debt, as well as the interest rates paid on it.
Atmos Energy has a debt to EBITDA ratio of 4.6, which signals significant debt, but is still fairly reasonable for most types of businesses. However, its interest coverage of 11.4 is very high, suggesting that interest charges on debt are currently quite low. One way Atmos Energy could beat its debt would be to stop borrowing more but continue to increase its EBIT by around 16%, as it did last year. There is no doubt that we learn the most about debt from the balance sheet. But it is future profits, more than anything, that will determine Atmos Energy’s ability to maintain a healthy balance sheet in the future. So, if you want to see what the professionals think, you might find this free analyst earnings forecast report interesting.
But our last consideration is also important, because a business cannot pay its debts with paper profits; he needs hard cash. The logical step is therefore to examine the proportion of this EBIT that corresponds to the actual free cash flow. Over the past three years Atmos Energy has recorded substantial total negative free cash flow. While this may be the result of spending on growth, it makes debt much riskier.
Our point of view
The conversion of Atmos Energy’s EBIT to free cash flow was a real negative on this analysis, although the other factors we took into account cast it in a better light. For example, his interest coverage was refreshing. It should also be noted that companies in the gas utility sector like Atmos Energy generally use debt without a problem. Taking the above factors together, we believe that Atmos Energy’s debt presents certain risks to the business. So while this leverage increases returns on equity, we wouldn’t really want to see it increase from here. When analyzing debt levels, the balance sheet is the obvious starting point. But at the end of the day, every business can contain risks that exist off the balance sheet. For example, Atmos Energy has 3 warning signs (and 2 which are a bit rude) we think you should be aware of.
If, after all of this, you’re more interested in a fast-growing company with a strong balance sheet, take a quick look at our list of cash net growth stocks.
If you decide to trade Atmos Energy, use the cheapest platform * which is ranked # 1 overall by Barron’s, Interactive Brokers. Trade stocks, options, futures, currencies, bonds and funds in 135 markets, all from one integrated account.
This Simply Wall St article is general in nature. It does not constitute a recommendation to buy or sell shares and does not take into account your goals or your financial situation. Our aim is to bring you long-term, targeted analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price sensitive companies or qualitative documents. Simply Wall St has no position in the mentioned stocks.
*Interactive Brokers Ranked Least Expensive Broker By StockBrokers.com Online Annual Review 2020
Do you have any feedback on this item? Are you worried about the content? Get in touch with us directly. You can also send an email to the editorial team (at) simplywallst.com.