David Iben put it well when he said, ‘Volatility is not a risk we care about. What we care about is avoiding the 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. Importantly, NextEra Energy, Inc. (NYSE:NEE) does carry debt. But should shareholders be worried about its use of debt?
When Is Debt A Problem?
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. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.
What Is NextEra Energy’s Debt?
You can click the graphic below for the historical numbers, but it shows that as of March 2020 NextEra Energy had US$47.2b of debt, an increase on US$40.2b, over one year. However, it also had US$3.34b in cash, and so its net debt is US$43.8b.
How Healthy Is NextEra Energy’s Balance Sheet?
According to the last reported balance sheet, NextEra Energy had liabilities of US$13.7b due within 12 months, and liabilities of US$65.8b due beyond 12 months. Offsetting these obligations, it had cash of US$3.34b as well as receivables valued at US$2.62b due within 12 months. So it has liabilities totalling US$73.6b more than its cash and near-term receivables, combined.
This deficit is considerable relative to its very significant market capitalization of US$120.5b, so it does suggest shareholders should keep an eye on NextEra Energy’s use of debt. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry.
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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.
While NextEra Energy’s debt to EBITDA ratio (4.1) suggests that it uses some debt, its interest cover is very weak, at 2.2, suggesting high leverage. So shareholders should probably be aware that interest expenses appear to have really impacted the business lately. Looking on the bright side, NextEra Energy boosted its EBIT by a silky 36% in the last year. Like the milk of human kindness that sort of growth increases resilience, making the company more capable of managing debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine NextEra Energy’s ability to maintain a healthy balance sheet going forward. 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. During the last three years, NextEra Energy burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.
NextEra Energy’s conversion of EBIT to free cash flow and interest cover definitely weigh on it, in our esteem. But the good news is it seems to be able to grow its EBIT with ease. We should also note that Electric Utilities industry companies like NextEra Energy commonly do use debt without problems. Taking the abovementioned factors together we do think NextEra Energy’s debt poses some risks to the business. While that debt can boost returns, we think the company has enough leverage now. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet – far from it. Case in point: We’ve spotted 2 warning signs for NextEra Energy you should be aware of, and 1 of them is concerning.
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.
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This article by Simply Wall St is general in nature. 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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