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 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. Importantly, UGI Corporation (NYSE:UGI) does carry debt. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

How Much Debt Does UGI Carry?

As you can see below, UGI had US$7.38b of debt at December 2023, down from US$7.72b a year prior. However, because it has a cash reserve of US$204.0m, its net debt is less, at about US$7.18b.

How Healthy Is UGI's Balance Sheet?

According to the last reported balance sheet, UGI had liabilities of US$2.34b due within 12 months, and liabilities of US$8.94b due beyond 12 months. Offsetting this, it had US$204.0m in cash and US$1.31b in receivables that were due within 12 months. So it has liabilities totalling US$9.77b more than its cash and near-term receivables, combined.

This deficit casts a shadow over the US$4.93b company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. At the end of the day, UGI would probably need a major re-capitalization if its creditors were to demand repayment.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Weak interest cover of 1.6 times and a disturbingly high net debt to EBITDA ratio of 6.3 hit our confidence in UGI like a one-two punch to the gut. The debt burden here is substantial. Worse, UGI's EBIT was down 23% over the last year. If earnings continue to follow that trajectory, paying off that debt load will be harder than convincing us to run a marathon in the rain. 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 UGI 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. Looking at the most recent three years, UGI recorded free cash flow of 26% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

Our View

To be frank both UGI's EBIT growth rate and its track record of staying on top of its total liabilities make us rather uncomfortable with its debt levels. And furthermore, its interest cover also fails to instill confidence. We should also note that Gas Utilities industry companies like UGI commonly do use debt without problems. Considering all the factors previously mentioned, we think that UGI really is carrying too much debt. To our minds, that means the stock is rather high risk, and probably one to avoid; but to each their own (investing) style. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. We've identified 2 warning signs with UGI (at least 1 which doesn't sit too well with us) , and understanding them should be part of your investment process.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.