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. Importantly, EVN AG (VIE:EVN) does carry debt. But should shareholders be worried about its use of debt?
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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
See our latest analysis for EVN
What Is EVN's Net Debt?
You can click the graphic below for the historical numbers, but it shows that as of March 2021 EVN had €1.20b of debt, an increase on €1.06b, over one year. However, it does have €625.0m in cash offsetting this, leading to net debt of about €579.0m.
How Strong Is EVN's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that EVN had liabilities of €943.4m due within 12 months and liabilities of €3.19b due beyond that. Offsetting this, it had €625.0m in cash and €605.9m in receivables that were due within 12 months. So it has liabilities totalling €2.90b more than its cash and near-term receivables, combined.
This is a mountain of leverage relative to its market capitalization of €3.57b. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.
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.
EVN's net debt is only 1.0 times its EBITDA. And its EBIT covers its interest expense a whopping 50.6 times over. So we're pretty relaxed about its super-conservative use of debt. Another good sign is that EVN has been able to increase its EBIT by 21% in twelve months, making it easier to pay down debt. 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 EVN 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. Over the most recent three years, EVN recorded free cash flow worth 59% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.
Our View
EVN's interest cover suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. But truth be told we feel its level of total liabilities does undermine this impression a bit. We would also note that Electric Utilities industry companies like EVN commonly do use debt without problems. All these things considered, it appears that EVN can comfortably handle its current debt levels. Of course, while this leverage can enhance returns on equity, it does bring more risk, so it's worth keeping an eye on this one. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 2 warning signs for EVN you should be aware of.
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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About WBAG:EVN
EVN
Provides energy and environmental services for private and business customers, and municipalities.
Very undervalued with solid track record and pays a dividend.