We believe ONEOK (NYSE: OKE) is taking risks with its debt

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David Iben put it well when he said: “Volatility is not a risk we care about. What matters to us is to avoid the permanent loss of capital. ‘ When we think about how risky a business is, we always like to look at its use of debt because debt overload can lead to bankruptcy. Like many other companies ONEOK, Inc. (NYSE: OKE) uses debt. But should shareholders be concerned about its use of debt?

What risk does debt entail?

Generally speaking, debt only becomes a real problem when a company cannot repay it easily, either by raising capital or with its own cash flow. An integral part of capitalism is the process of “creative destruction” where bankrupt companies are ruthlessly liquidated by their bankers. However, a more common (but still painful) scenario is that he must raise new equity at low cost, thereby diluting shareholders over the long term. By replacing dilution, however, debt can be a very good tool for companies that need capital to invest in growth at high rates of return. When we think of a business’s use of debt, we first look at cash flow and debt together.

Discover our latest analysis for ONEOK

What is ONEOK’s net debt?

As you can see below, ONEOK had $ 14.3 billion in debt, as of June 2021, which is roughly the same as the year before. You can click on the graph for more details. However, given that it has a cash reserve of US $ 374.4 million, its net debt is lower, at approximately US $ 13.9 billion.

NYSE: OKE Debt to Equity History October 11, 2021

How strong is ONEOK’s balance sheet?

We can see from the most recent balance sheet that ONEOK had liabilities of US $ 2.39 billion maturing within one year and liabilities of US $ 15.1 billion maturing beyond that. In compensation for these obligations, he had cash of US $ 374.4 million as well as 12-month receivables valued at US $ 1.09 billion. It therefore has liabilities totaling $ 16.1 billion more than its cash and short-term receivables combined.

ONEOK has a very large market capitalization of US $ 27.5 billion, so it could most likely raise funds to improve its balance sheet, should the need arise. But it is clear that it is absolutely necessary to take a close look at whether it can manage its debt without dilution.

We use two main ratios to inform us about the levels of debt compared to earnings. The first is net debt divided by earnings before interest, taxes, depreciation, and amortization (EBITDA), while the second is the number of times its profit before interest and taxes (EBIT) covers its interest expense (or its coverage of interest, for short). Thus, we consider debt versus earnings with and without amortization charges.

ONEOK’s debt is 4.7 times its EBITDA, and its EBIT covers its interest expense 3.2 times. Overall, this implies that while we wouldn’t like to see debt levels rise, we believe it can handle its current leverage. On a lighter note, note that ONEOK has increased its EBIT by 28% over the past year. If sustained, this growth should cause this debt to evaporate like scarce drinking water during an unusually hot summer. The balance sheet is clearly the area you need to focus on when analyzing debt. But it is future profits, more than anything, that will determine ONEOK’s ability to maintain a healthy balance sheet in the future. So, if you want to see what the professionals think, you might find this free analyst earnings forecast report interesting.

But our last consideration is also important, because a business cannot pay its debts with paper profits; he needs hard cash. It is therefore worth checking to what extent this EBIT is supported by free cash flow. Over the past three years, ONEOK has recorded substantial total negative free cash flow. While this may be the result of spending on growth, it makes debt much riskier.

Our point of view

Reflecting on ONEOK’s attempt to convert EBIT to free cash flow, we are certainly not enthusiastic. But on the positive side, its EBIT growth rate is a good sign and makes us more optimistic. Once we consider all of the above factors together it seems to us that ONEOK’s debt makes it a bit risky. Some people like this kind of risk, but we are aware of the potential pitfalls, so we would probably prefer him to carry less debt. When analyzing debt levels, the balance sheet is the obvious starting point. However, not all investment risks lie on the balance sheet – far from it. For example, we have identified 2 warning signs for ONEOK that you need to be aware of.

At the end of the day, it’s often best to focus on businesses with no net debt. You can access our special list of these companies (all with a history of profit growth). It’s free.

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

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