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. Importantly, EnBW Energie Baden-Württemberg AG (ETR:EBK) does carry debt. But the real question is whether this debt is making the company risky.

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for EnBW Energie Baden-Württemberg

How Much Debt Does EnBW Energie Baden-Württemberg Carry?

The chart below, which you can click on for greater detail, shows that EnBW Energie Baden-Württemberg had €14.2b in debt in March 2023; about the same as the year before. However, because it has a cash reserve of €6.13b, its net debt is less, at about €8.08b.

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

According to the last reported balance sheet, EnBW Energie Baden-Württemberg had liabilities of €25.7b due within 12 months, and liabilities of €30.2b due beyond 12 months. On the other hand, it had cash of €6.13b and €7.05b worth of receivables due within a year. So it has liabilities totalling €42.7b more than its cash and near-term receivables, combined.

This deficit casts a shadow over the €23.2b company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. At the end of the day, EnBW Energie Baden-Württemberg would probably need a major re-capitalization if its creditors were to demand repayment.

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.

EnBW Energie Baden-Württemberg has a low net debt to EBITDA ratio of only 1.5. And its EBIT easily covers its interest expense, being 4k times the size. So we're pretty relaxed about its super-conservative use of debt. Even more impressive was the fact that EnBW Energie Baden-Württemberg grew its EBIT by 435% over twelve months. If maintained that growth will make the debt even more manageable in the years ahead. 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 always check how much of that EBIT is translated into free cash flow. Looking at the most recent three years, EnBW Energie Baden-Württemberg recorded free cash flow of 36% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Our View

We feel some trepidation about EnBW Energie Baden-Württemberg's difficulty level of total liabilities, but we've got positives to focus on, too. To wit both its interest cover and EBIT growth rate were encouraging signs. 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 all the angles mentioned above, it does seem to us that EnBW Energie Baden-Württemberg is a somewhat risky investment as a result of its debt. Not all risk is bad, as it can boost share price returns if it pays off, but this debt risk is worth keeping in mind. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. Be aware that EnBW Energie Baden-Württemberg is showing 2 warning signs in our investment analysis , you should know about...

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.