Does Enbridge (TSE:ENB) Have A Healthy Balance Sheet?

Legendary fund manager Li Lu (who Charlie Munger backed) once said, ‘The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.’ So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We can see that Enbridge Inc. (TSE:ENB) does use debt in its business. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. If things get really bad, the lenders can take control of the business. 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. The first step when considering a company’s debt levels is to consider its cash and debt together.

See our latest analysis for Enbridge

What Is Enbridge’s Debt?

As you can see below, Enbridge had CA$79.5b of debt, at June 2023, which is about the same as the year before. You can click the chart for greater detail. And it doesn’t have much cash, so its net debt is about the same.

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TSX:ENB Debt to Equity History August 22nd 2023

How Strong Is Enbridge’s Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Enbridge had liabilities of CA$14.0b due within 12 months and liabilities of CA$95.9b due beyond that. Offsetting these obligations, it had cash of CA$1.29b as well as receivables valued at CA$3.89b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CA$104.7b.

When you consider that this deficiency exceeds the company’s huge CA$95.6b 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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

With a net debt to EBITDA ratio of 5.6, it’s fair to say Enbridge does have a significant amount of debt. However, its interest coverage of 2.7 is reasonably strong, which is a good sign. On the other hand, Enbridge grew its EBIT by 22% in the last year. If sustained, this growth should make that debt evaporate like a scarce drinking water during an unnaturally hot summer. 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 Enbridge can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. During the last three years, Enbridge produced sturdy free cash flow equating to 55% of its EBIT, about what we’d expect. This cold hard cash means it can reduce its debt when it wants to.

Our View

Enbridge’s net debt to EBITDA was a real negative on this analysis, although the other factors we considered cast it in a significantly better light. For example its EBIT growth rate was refreshing. When we consider all the factors discussed, it seems to us that Enbridge is taking some risks with its use of debt. While that debt can boost returns, we think the company has enough leverage now. There’s no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet – far from it. To that end, you should learn about the 3 warning signs we’ve spotted with Enbridge (including 1 which is a bit unpleasant) .

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

Valuation is complex, but we’re helping make it simple.

Find out whether Enbridge is potentially over or undervalued by checking out our comprehensive analysis, which includes fair value estimates, risks and warnings, dividends, insider transactions and financial health.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.

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