Targa Resources (NYSE: TRGP) has a somewhat strained balance sheet
Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett said “volatility is far from risk.” So it seems like smart money knows that debt – which is usually involved in bankruptcies – is a very important factor, when you assess the level of risk of a business. We notice that Targa Resources Corp. (NYSE: TRGP) has debt on its balance sheet. But the most important question is: what risk does this debt create?
When is debt dangerous?
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. An integral part of capitalism is the process of “creative destruction” where bankrupt companies are ruthlessly liquidated by their bankers. 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. That said, the most common situation is where a business manages its debt reasonably well – and to its own advantage. 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 Targa Resources
What is the debt of Targa Resources?
As you can see below, Targa Resources had US $ 6.76 billion in debt in September 2021, up from US $ 7.88 billion the year before. On the other hand, it has $ 228.6 million in cash, resulting in net debt of around $ 6.53 billion.
How healthy is Targa Resources’ balance sheet?
We can see from the most recent balance sheet that Targa Resources had liabilities of US $ 2.87 billion maturing within one year and liabilities of US $ 6.95 billion maturing beyond that. . On the other hand, he had cash of US $ 228.6 million and receivables worth US $ 1.29 billion within a year. It therefore has liabilities totaling US $ 8.30 billion more than its cash and short-term receivables combined.
This deficit is substantial compared to its very large market capitalization of US $ 11.6 billion, so he suggests shareholders keep an eye on Targa Resources’ use of debt. This suggests that shareholders would be greatly diluted if the company needed to consolidate its balance sheet quickly.
We use two main ratios to inform us about the levels of debt compared to earnings. The first is net debt divided by earnings before interest, taxes, depreciation, and amortization (EBITDA), while the second is the number of times its earnings before interest and taxes (EBIT) covers its interest expense (or its coverage of interest, for short). In this way, we consider both the absolute amount of debt, as well as the interest rates paid on it.
Targa Resources has a debt to EBITDA ratio of 3.0 and its EBIT covered its interest expense 3.3 times. Overall, this implies that while we wouldn’t like to see debt levels rise, we believe it can handle its current leverage. Fortunately, Targa Resources has increased its EBIT by 4.9% over the past year, slowly reducing its debt to earnings. The balance sheet is clearly the area to focus on when analyzing debt. But ultimately, the company’s future profitability will decide whether Targa Resources can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free Analyst Profit Forecast report interesting.
Finally, a business can only pay off its debts with hard cash, not with book profits. It is therefore worth checking to what extent this EBIT is supported by free cash flow. Over the past three years, Targa Resources has recorded total negative free cash flow. Debt is much riskier for companies with unreliable free cash flow, so shareholders should hope that past spending will produce free cash flow in the future.
Our point of view
Reflecting on Targa Resources’ attempt to convert EBIT into free cash flow, we are certainly not enthusiastic. But at least its EBIT growth rate isn’t that bad. Overall, we think it’s fair to say that Targa Resources has enough debt that there is real risk around the balance sheet. If all goes well, this should increase returns, but on the other hand, the risk of permanent capital loss is increased by debt. When analyzing debt levels, the balance sheet is the obvious place to start. However, not all investment risks lie on the balance sheet – far from it. Note that Targa Resources displays 2 warning signs in our investment analysis , you must know…
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-flow net-growth stocks.
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