Here's Why VERBUND (VIE:VER) Can Manage Its Debt Responsibly

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. We can see that VERBUND AG (VIE:VER) does use debt in its business. But is this debt a concern to shareholders?

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for VERBUND

How Much Debt Does VERBUND Carry?

The image below, which you can click on for greater detail, shows that VERBUND had debt of €2.37b at the end of September 2024, a reduction from €2.61b over a year. However, because it has a cash reserve of €1.24b, its net debt is less, at about €1.14b.

How Healthy Is VERBUND's Balance Sheet?

We can see from the most recent balance sheet that VERBUND had liabilities of €2.35b falling due within a year, and liabilities of €5.79b due beyond that. Offsetting this, it had €1.24b in cash and €905.5m in receivables that were due within 12 months. So it has liabilities totalling €6.00b more than its cash and near-term receivables, combined.

While this might seem like a lot, it is not so bad since VERBUND has a huge market capitalization of €24.4b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.

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.

VERBUND's net debt is only 0.32 times its EBITDA. And its EBIT covers its interest expense a whopping 172 times over. So we're pretty relaxed about its super-conservative use of debt. It is just as well that VERBUND's load is not too heavy, because its EBIT was down 30% over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine VERBUND's ability to maintain a healthy balance sheet going forward. 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 business needs free cash flow to pay off debt; accounting profits just don't cut it. So we always check how much of that EBIT is translated into free cash flow. Over the most recent three years, VERBUND recorded free cash flow worth 60% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Our View

VERBUND's EBIT growth rate was a real negative on this analysis, although the other factors we considered were considerably better. In particular, we are dazzled with its interest cover. It's also worth noting that VERBUND is in the Electric Utilities industry, which is often considered to be quite defensive. Considering this range of data points, we think VERBUND is in a good position to manage its debt levels. Having said that, the load is sufficiently heavy that we would recommend any shareholders keep a close eye on it. 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 VERBUND you should be aware of, and 1 of them shouldn't be ignored.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.