MGE Energy (NASDAQ:MGEE) takes on some risk by using debt

External fund manager Li Lu, backed by Berkshire Hathaway’s Charlie Munger, 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 wise Minds know that debt – which is usually associated with bankruptcies – is a very important factor when assessing a company’s risk. We take note of that MGE Energy, Inc. (NASDAQ:MGEE) has debt on its balance sheet. But the real question is whether this debt makes the company risky.

Why does debt pose risks?

Debt is a tool that helps companies grow. However, if a company is unable to repay its lenders, it is at their mercy. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more common (but still costly) situation is where a company must dilute shareholders at a cheap share price just to get debt under control. Of course, debt can be an important tool in businesses, especially capital-intensive businesses. When we think about a company’s use of debt, we first consider cash and debt together.

Check out our latest analysis for MGE Energy

How much debt does MGE Energy have?

As you can see below, MGE Energy had $769.0 million of debt at the end of September 2024, up from $717.1 million a year ago. Click on the image for more details. Net debt is about the same since there isn’t much cash.

How strong is MGE Energy’s balance sheet?

The most recent balance sheet shows that MGE Energy had liabilities of US$149.6m due within a year, and liabilities of US$1.40b due beyond that . Offsetting this, it had US$14.9m in cash and US$85.3m in receivables due within 12 months. So its liabilities total US$1.45b more than its cash and short-term receivables combined.

While this may seem like a lot, it’s not that bad since MGE Energy has a market capitalization of US$3.77 billion, and therefore could likely strengthen its balance sheet by raising capital if needed. Nevertheless, it is worth taking a close look at your ability to repay your debts.

We measure a company’s debt load relative to its earnings power by dividing its net debt by its earnings before interest, tax, depreciation, and amortization (EBITDA) and calculating how easily its earnings before interest and tax (EBIT) can cover its interest expense (interest cover). ). We take into account both the absolute amount of the debt and the interest paid on it.

MGE Energy has a debt-to-EBITDA ratio of 3.1, and its EBIT covered its interest expense by 4.7 times. This suggests that while the debt is significant, we wouldn’t call it problematic. Unfortunately, MGE Energy suffered a 5.0% decline in EBIT over the last twelve months. If profits continue to fall, managing debt will be difficult, like delivering hot soup on a unicycle. When analyzing debt levels, the balance sheet is the obvious place to start. But it is future earnings that will determine whether MGE Energy can maintain a healthy balance sheet in the future. So if you’re focused on the future, you can look at that free Report with analyst profit forecasts.

But our final consideration is also important, because a company cannot pay off its debts with paper profits; it takes cash. So we always check how much of that EBIT is converted into free cash flow. Over the past three years, MGE Energy has had negative free cash flow overall. Debt is far riskier for companies with unreliable free cash flow, so shareholders should hope that past spending will produce free cash flow in the future.

Our view

When we think about MGE Energy’s attempt to convert EBIT into free cash flow, we’re certainly not thrilled. However, the company’s ability to manage its total liabilities is not a cause for concern. We should also note that utilities companies like MGE Energy often make good use of their debt. When we consider all of the above factors together, it seems to us that MGE Energy’s debt makes the company somewhat risky. That’s not necessarily a bad thing, but in general we would feel more comfortable with less leverage. There is no doubt that the balance sheet is where we learn the most about debt. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We discovered it 2 warning signs for MGE Energy You should be aware of that.

If you’re interested in investing in companies that can grow profits without the burden of debt, then check this out free List of growing companies that have net cash on the balance sheet.

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