Warren Buffett famously said, ‘Volatility is far from synonymous with risk.’ It’s only natural to consider a company’s balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We can see that NiSource Inc. (NYSE:NI) does use debt in its business. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

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. If things get really bad, the lenders can take control of the business. 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, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company’s use of debt, we first look at cash and debt together.

What Is NiSource’s Debt?

As you can see below, NiSource had US$9.75b of debt, at December 2021, which is about the same as the year before. You can click the chart for greater detail. Net debt is about the same, since the it doesn’t have much cash.

A Look At NiSource’s Liabilities

The latest balance sheet data shows that NiSource had liabilities of US$2.75b due within a year, and liabilities of US$14.1b falling due after that. Offsetting these obligations, it had cash of US$84.2m as well as receivables valued at US$925.2m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$15.9b.

When you consider that this deficiency exceeds the company’s huge US$13.0b market capitalization, you might well be inclined to review the balance sheet intently. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price.

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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

NiSource has a rather high debt to EBITDA ratio of 5.6 which suggests a meaningful debt load. But the good news is that it boasts fairly comforting interest cover of 3.1 times, suggesting it can responsibly service its obligations. The good news is that NiSource improved its EBIT by 8.2% over the last twelve months, thus gradually reducing its debt levels relative to its earnings. 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 NiSource can strengthen its balance sheet over time.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So it’s worth checking how much of that EBIT is backed by free cash flow. During the last three years, NiSource burned a lot of cash. 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

To be frank both NiSource’s net debt to EBITDA and its track record of converting EBIT to free cash flow make us rather uncomfortable with its debt levels. But on the bright side, its EBIT growth rate is a good sign, and makes us more optimistic. We should also note that Integrated Utilities industry companies like NiSource commonly do use debt without problems. We’re quite clear that we consider NiSource to be really rather risky, as a result of its balance sheet health. For this reason we’re pretty cautious about the stock, and we think shareholders should keep a close eye on its liquidity.