Here's Why EnBW Energie Baden-Württemberg (ETR:EBK) Has A Meaningful Debt Burden

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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. As with many other companies EnBW Energie Baden-Württemberg AG (ETR:EBK) makes use of debt. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

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, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for EnBW Energie Baden-Württemberg

How Much Debt Does EnBW Energie Baden-Württemberg Carry?

You can click the graphic below for the historical numbers, but it shows that as of September 2020 EnBW Energie Baden-Württemberg had €9.14b of debt, an increase on €8.33b, over one year. However, because it has a cash reserve of €1.99b, its net debt is less, at about €7.15b.

A Look At EnBW Energie Baden-Württemberg's Liabilities

Zooming in on the latest balance sheet data, we can see that EnBW Energie Baden-Württemberg had liabilities of €9.30b due within 12 months and liabilities of €25.3b due beyond that. Offsetting these obligations, it had cash of €1.99b as well as receivables valued at €3.27b due within 12 months. So its liabilities total €29.4b more than the combination of its cash and short-term receivables.

This deficit casts a shadow over the €15.2b company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. At the end of the day, EnBW Energie Baden-Württemberg would probably need a major re-capitalization if its creditors were to demand repayment.

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). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

EnBW Energie Baden-Württemberg's debt is 2.8 times its EBITDA, and its EBIT cover its interest expense 5.1 times over. This suggests that while the debt levels are significant, we'd stop short of calling them problematic. Notably, EnBW Energie Baden-Württemberg's EBIT launched higher than Elon Musk, gaining a whopping 223% on last year. 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. During the last three years, EnBW Energie Baden-Württemberg burned a lot of cash. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Our View

To be frank both EnBW Energie Baden-Württemberg's conversion of EBIT to free cash flow and its track record of staying on top of its total liabilities make us rather uncomfortable with its debt levels. But on the bright side, its EBIT growth rate is a good sign, and makes us more optimistic. It's also worth noting that EnBW Energie Baden-Württemberg is in the Electric Utilities industry, which is often considered to be quite defensive. Looking at the bigger picture, it seems clear to us that EnBW Energie Baden-Württemberg's use of debt is creating risks for the company. If everything goes well that may pay off but the downside of this debt is a greater risk of permanent losses. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that EnBW Energie Baden-Württemberg is showing 2 warning signs in our investment analysis , and 1 of those shouldn't be ignored...

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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