Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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. We can see that EnBW Energie Baden-Württemberg AG (ETR:EBK) does use debt in its business. But is this debt a concern to shareholders?
When Is Debt Dangerous?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first thing to do when considering how much debt a business uses is to look at its 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 June 2024 EnBW Energie Baden-Württemberg had €16.3b of debt, an increase on €14.8b, over one year. On the flip side, it has €7.44b in cash leading to net debt of about €8.90b.
A Look At EnBW Energie Baden-Württemberg's Liabilities
According to the last reported balance sheet, EnBW Energie Baden-Württemberg had liabilities of €16.2b due within 12 months, and liabilities of €29.7b due beyond 12 months. On the other hand, it had cash of €7.44b and €5.34b worth of receivables due within a year. So it has liabilities totalling €33.1b more than its cash and near-term receivables, combined.
The deficiency here weighs heavily on the €17.9b company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. 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.
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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.
With a debt to EBITDA ratio of 2.5, EnBW Energie Baden-Württemberg uses debt artfully but responsibly. And the alluring interest cover (EBIT of 8.4 times interest expense) certainly does not do anything to dispel this impression. Importantly, EnBW Energie Baden-Württemberg's EBIT fell a jaw-dropping 46% 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 if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.
Finally, a company can only pay off debt with cold hard cash, not accounting profits. So it's worth checking how much of that EBIT is backed by free cash flow. Over the last three years, EnBW Energie Baden-Württemberg saw substantial negative free cash flow, in total. 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 EBIT growth rate 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 interest cover 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. 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. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. These risks can be hard to spot. Every company has them, and we've spotted 4 warning signs for EnBW Energie Baden-Württemberg (of which 2 are significant!) you should know about.
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.
About XTRA:EBK
EnBW Energie Baden-Württemberg
Operates as an integrated energy company in Germany, rest of Europe, and internationally.
Excellent balance sheet second-rate dividend payer.