Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. We note that Portland General Electric Company (NYSE:POR) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.
When Is Debt A Problem?
Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
How Much Debt Does Portland General Electric Carry?
The chart below, which you can click on for greater detail, shows that Portland General Electric had US$2.39b in debt in June 2019; about the same as the year before. And it doesn't have much cash, so its net debt is about the same.
A Look At Portland General Electric's Liabilities
The latest balance sheet data shows that Portland General Electric had liabilities of US$440.0m due within a year, and liabilities of US$5.02b falling due after that. On the other hand, it had cash of US$11.0m and US$222.0m worth of receivables due within a year. So it has liabilities totalling US$5.22b more than its cash and near-term receivables, combined.
Given this deficit is actually higher than the company's market capitalization of US$4.96b, we think shareholders really should watch Portland General Electric's debt levels, like a parent watching their child ride a bike for the first time. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer extensive dilution.
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).
While Portland General Electric's debt to EBITDA ratio (3.3) suggests that it uses some debt, its interest cover is very weak, at 2.4, suggesting high leverage. In large part that's due to the company's significant depreciation and amortisation charges, which arguably mean its EBITDA is a very generous measure of earnings, and its debt may be more of a burden than it first appears. It seems clear that the cost of borrowing money is negatively impacting returns for shareholders, of late. Another concern for investors might be that Portland General Electric's EBIT fell 12% in the last year. If things keep going like that, handling the debt will about as easy as bundling an angry house cat into its travel box. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Portland General Electric 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.
Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. In the last three years, Portland General Electric created free cash flow amounting to 11% of its EBIT, an uninspiring performance. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.
To be frank both Portland General Electric's EBIT growth rate and its track record of covering its interest expense with its EBIT make us rather uncomfortable with its debt levels. And even its conversion of EBIT to free cash flow fails to inspire much confidence. It's also worth noting that Portland General Electric is in the Electric Utilities industry, which is often considered to be quite defensive. We're quite clear that we consider Portland General Electric to be really rather risky, as a result of its balance sheet health. So we're almost as wary of this stock as a hungry kitten is about falling into its owner's fish pond: once bitten, twice shy, as they say. Above most other metrics, we think its important to track how fast earnings per share is growing, if at all. If you've also come to that realization, you're in luck, because today you can view this interactive graph of Portland General Electric's earnings per share history for free.
If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.
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