EnBW Energie Baden-Württemberg (ETR:EBK) Seems To Be Using A Lot Of Debt

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says '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. We note that EnBW Energie Baden-Württemberg AG (ETR:EBK) does have debt on its balance sheet. 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. 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.

View our latest analysis for EnBW Energie Baden-Württemberg

What Is EnBW Energie Baden-Württemberg's Net Debt?

As you can see below, at the end of March 2024, EnBW Energie Baden-Württemberg had €16.6b of debt, up from €14.2b a year ago. Click the image for more detail. On the flip side, it has €8.91b in cash leading to net debt of about €7.71b.

How Healthy Is EnBW Energie Baden-Württemberg's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that EnBW Energie Baden-Württemberg had liabilities of €19.2b due within 12 months and liabilities of €30.6b due beyond that. Offsetting these obligations, it had cash of €8.91b as well as receivables valued at €6.07b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by €34.8b.

This deficit casts a shadow over the €18.5b company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. After all, EnBW Energie Baden-Württemberg would likely require a major re-capitalisation if it had to pay its creditors today.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

EnBW Energie Baden-Württemberg's net debt is sitting at a very reasonable 2.3 times its EBITDA, while its EBIT covered its interest expense just 6.6 times last year. While these numbers do not alarm us, it's worth noting that the cost of the company's debt is having a real impact. Importantly, EnBW Energie Baden-Württemberg's EBIT fell a jaw-dropping 51% in the last twelve months. If that earnings trend continues then paying off its debt will be about as easy as herding cats on to a roller coaster. There's no doubt that we learn most about debt from the balance sheet. But it is EnBW Energie Baden-Württemberg's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Considering the last three years, EnBW Energie Baden-Württemberg actually recorded a cash outflow, overall. Debt is usually more expensive, and almost always more risky in the hands of a company with negative free cash flow. Shareholders ought to hope for an improvement.

Our View

On the face of it, EnBW Energie Baden-Württemberg's EBIT growth rate left us tentative about the stock, and its level of total liabilities was no more enticing than the one empty restaurant on the busiest night of the year. But at least it's pretty decent at covering its interest expense with its EBIT; that's encouraging. We should also note that Electric Utilities industry companies like EnBW Energie Baden-Württemberg commonly do use debt without problems. Taking into account all the aforementioned factors, it looks like EnBW Energie Baden-Württemberg has too much debt. That sort of riskiness is ok for some, but it certainly doesn't float our boat. 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. For example, we've discovered 4 warning signs for EnBW Energie Baden-Württemberg (2 are potentially serious!) that you should be aware of before investing here.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.

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