Is Atmos Energy (NYSE: ATO) Using Too Much Debt?

Berkshire Hathaway’s Charlie Munger-backed external fund manager Li Lu is quick to say this when he says “The biggest risk in investing is not price volatility, but if you will suffer a loss. permanent capital “. So it can be obvious that you need to consider debt, when you think about how risky a given stock is, because too much debt can sink a business. Like many other companies Atmos energy company (NYSE: ATO) uses debt. But should shareholders be concerned about its use of debt?

What risk does debt entail?

Debt is a tool to help businesses grow, but if a business is unable to repay its lenders, then it exists at their mercy. Ultimately, if the company cannot meet its legal debt repayment obligations, shareholders could walk away with nothing. However, a more common (but still painful) scenario is that he has to raise new equity at low cost, thereby constantly diluting shareholders. That said, the most common situation is where a business manages its debt reasonably well – and to its own advantage. The first step in examining a company’s debt levels is to consider its cash flow and debt together.

What is Atmos Energy’s debt?

As you can see below, at the end of September 2021, Atmos Energy had $ 7.31 billion in debt, up from $ 4.52 billion a year ago. Click on the image for more details. Net debt is about the same because it doesn’t have a lot of cash.

NYSE Debt to Equity History: ATO November 20, 2021

How strong is Atmos Energy’s balance sheet?

We can see from the most recent balance sheet that Atmos Energy had liabilities of US $ 3.51 billion maturing within one year and liabilities of US $ 8.19 billion maturing within one year. of the. In return, he had $ 116.7 million in cash and $ 343.0 million in receivables due within 12 months. Its liabilities therefore total US $ 11.2 billion more than the combination of its cash and short-term receivables.

This is a mountain of leverage, even compared to its gargantuan market cap of US $ 12.6 billion. If its lenders asked it to consolidate the balance sheet, shareholders would likely face severe dilution.

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 profit before interest and taxes (EBIT) covers its interest expense (or its coverage of interest, for short). Thus, we consider debt versus earnings with and without amortization expenses.

Strangely, Atmos Energy has a very high EBITDA ratio of 5.3, which implies high debt, but strong interest coverage of 10.9. So either he has access to very cheap long-term debt or his interest charges will go up! Atmos Energy has increased its EBIT by 7.9% over the past year. While this hardly strikes us, it is a bright spot when it comes to debt. The balance sheet is clearly the area to focus on when analyzing debt. 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 are thinking, you might find this free report on analysts’ earnings forecasts Be interesting.

Finally, a business can only pay off its debts with hard cash, not with book profits. We therefore always check how much of this EBIT is converted into free cash flow. Over the past three years Atmos Energy has spent a lot of money. While investors no doubt expect this situation to reverse in due course, this clearly means its use of debt is riskier.

Our point of view

At first glance, Atmos Energy’s net debt to EBITDA left us hesitant about the stock, and its conversion from EBIT to free cash flow was no more appealing than the one empty restaurant on the way. the busiest night of the year. But at least it’s decent enough to cover its interest costs with its EBIT; it’s encouraging. It should also be noted that companies in the gas utility sector like Atmos Energy generally use debt without a problem. Once we consider all of the above factors together, it seems to us that Atmos Energy’s debt makes it a bit risky. This isn’t necessarily a bad thing, but we would generally feel more comfortable with less leverage. The balance sheet is clearly the area to focus on when analyzing debt. But at the end of the day, every business can contain risks that exist off the balance sheet. For example, Atmos Energy has 4 warning signs (and 2 which are significant) we think you should know.

Of course, if you are the type of investor who prefers to buy stocks without going into debt, then feel free to find out. our exclusive list of cash net growth stocks, today.

This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts using only unbiased methodology and our articles are not intended to be financial advice. 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.

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John A. Bogar