These 4 Measures Indicate That Atmos Energy (NYSE:ATO) Is Using Debt Extensively

Atmos Energy Corporation +1.89%

Atmos Energy Corporation

ATO

124.65

+1.89%

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. As with many other companies Atmos Energy Corporation (NYSE:ATO) makes use of debt. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Atmos Energy

What Is Atmos Energy's Debt?

The image below, which you can click on for greater detail, shows that Atmos Energy had debt of US$7.49b at the end of December 2023, a reduction from US$8.70b over a year. However, because it has a cash reserve of US$511.3m, its net debt is less, at about US$6.98b.

debt-equity-history-analysis
NYSE:ATO Debt to Equity History April 29th 2024

A Look At Atmos Energy's Liabilities

Zooming in on the latest balance sheet data, we can see that Atmos Energy had liabilities of US$1.17b due within 12 months and liabilities of US$11.2b due beyond that. Offsetting this, it had US$511.3m in cash and US$646.4m in receivables that were due within 12 months. So it has liabilities totalling US$11.3b more than its cash and near-term receivables, combined.

This deficit is considerable relative to its very significant market capitalization of US$17.6b, so it does suggest shareholders should keep an eye on Atmos Energy's use of debt. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry.

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). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Atmos Energy has net debt to EBITDA of 3.9 suggesting it uses a fair bit of leverage to boost returns. But the high interest coverage of 8.0 suggests it can easily service that debt. If Atmos Energy can keep growing EBIT at last year's rate of 19% over the last year, then it will find its debt load easier to manage. 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 Atmos Energy 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Over the last three years, Atmos Energy saw substantial negative free cash flow, in total. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Our View

Atmos Energy's struggle to convert EBIT to free cash flow had us second guessing its balance sheet strength, but the other data-points we considered were relatively redeeming. In particular, its EBIT growth rate was re-invigorating. We should also note that Gas Utilities industry companies like Atmos Energy commonly do use debt without problems. Taking the abovementioned factors together we do think Atmos Energy's debt poses some risks to the business. So while that leverage does boost returns on equity, we wouldn't really want to see it increase from here. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. To that end, you should be aware of the 2 warning signs we've spotted with Atmos Energy .

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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