Is ONEOK (NYSE:OKE) using too much debt?

Howard Marks said it well when he said that, rather than worrying about stock price volatility, “the possibility of permanent loss is the risk I worry about…and that every practical investor that I know is worried”. So it may be obvious that you need to take debt into account when thinking about the risk of a given stock, because too much debt can sink a business. We note that ONEOK, Inc. (NYSE:OKE) has debt on its balance sheet. But does this debt worry shareholders?

When is debt a problem?

Generally speaking, debt only becomes a real problem when a company cannot easily repay it, either by raising capital or with its own cash flow. An integral part of capitalism is the process of “creative destruction” where bankrupt companies are mercilessly liquidated by their bankers. Although not too common, we often see companies in debt permanently diluting their shareholders because lenders force them to raise capital at a ridiculous price. Of course, debt can be an important tool in businesses, especially capital-intensive businesses. The first step when considering a company’s debt levels is to consider its cash and debt together.

See our latest analysis for ONEOK

How much debt does ONEOK bear?

As you can see below, ONEOK had $13.8 billion in debt as of March 2022, roughly the same as the previous year. You can click on the graph for more details. Net debt is about the same, since she doesn’t have a lot of cash.

NYSE: OKE Debt to Equity History May 22, 2022

How healthy is ONEOK’s balance sheet?

The latest balance sheet data shows that ONEOK had liabilities of $3.48 billion due within the year, and liabilities of $14.5 billion due thereafter. As compensation for these obligations, it had cash of US$19.0 million as well as receivables valued at US$1.68 billion and payable within 12 months. Thus, its liabilities outweigh the sum of its cash and (short-term) receivables by $16.3 billion.

ONEOK has a very large market capitalization of US$28.4 billion, so it could very likely raise funds to improve its balance sheet, should the need arise. But it is clear that it must be carefully examined whether he can manage his debt without dilution.

We use two main ratios to inform us about debt to earnings levels. The first is net debt divided by earnings before interest, taxes, depreciation and amortization (EBITDA), while the second is how often its earnings before interest and taxes (EBIT) covers its interest expense (or its interests, for short). Thus, we consider debt to earnings with and without amortization and depreciation expense.

ONEOK has a debt/EBITDA ratio of 4.3 and its EBIT covered its interest expense 3.6 times. This suggests that while debt levels are significant, we will refrain from labeling them problematic. On a lighter note, note that ONEOK has increased its EBIT by 22% over the past year. If sustained, this growth should cause this debt to evaporate like scarce drinking water during an abnormally hot summer. When analyzing debt levels, the balance sheet is the obvious starting point. But ultimately, the company’s future profitability will decide whether ONEOK can strengthen its balance sheet over time. So if you are focused on the future, you can check out this free report showing analyst earnings forecast.

But our last consideration is also important, because a company cannot pay debt with paper profits; he needs cash. It is therefore worth checking how much of this EBIT is supported by free cash flow. Over the past three years, ONEOK has created free cash flow amounting to 5.9% of its EBIT, an interest-free performance. For us, such a low cash conversion creates a bit of paranoia about the ability to extinguish the debt.

Our point of view

ONEOK’s conversion of EBIT into free cash flow and net debt into EBITDA is definitely weighing on it, in our view. But the good news is that it looks like it could easily increase its EBIT. When we consider all the factors mentioned, it seems to us that ONEOK is taking risks with its recourse to debt. So even if this leverage increases return on equity, we wouldn’t really want to see it increase from now on. 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 outside of the balance sheet. To do this, you need to find out about the 4 warning signs we have spotted some with ONEOK (including 2 that are significant).

In the end, it’s often best to focus on companies that aren’t in debt. You can access our special list of these companies (all with a track record of earnings growth). It’s free.

This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.

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