Is EnBW Energie Baden-Württemberg (ETR:EBK) Using Too Much Debt?

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 seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. 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.

When Is Debt A Problem?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for EnBW Energie Baden-Württemberg

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

The image below, which you can click on for greater detail, shows that at December 2021 EnBW Energie Baden-Württemberg had debt of €11.3b, up from €9.61b in one year. On the flip side, it has €7.43b in cash leading to net debt of about €3.82b.

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

The latest balance sheet data shows that EnBW Energie Baden-Württemberg had liabilities of €34.2b due within a year, and liabilities of €28.5b falling due after that. On the other hand, it had cash of €7.43b and €6.33b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by €49.0b.

This deficit casts a shadow over the €22.5b 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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

EnBW Energie Baden-Württemberg's net debt to EBITDA ratio of about 1.5 suggests only moderate use of debt. And its commanding EBIT of 1k times its interest expense, implies the debt load is as light as a peacock feather. But the other side of the story is that EnBW Energie Baden-Württemberg saw its EBIT decline by 8.9% over the last year. That sort of decline, if sustained, will obviously make debt harder to handle. When analysing debt levels, the balance sheet is the obvious place to start. 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 business needs free cash flow to pay off debt; accounting profits just don't cut it. 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 recorded free cash flow worth a fulsome 98% of its EBIT, which is stronger than we'd usually expect. That puts it in a very strong position to pay down debt.

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. For example, its interest cover and conversion of EBIT to free cash flow give us some confidence in its ability to manage its debt. We should also note that Electric Utilities industry companies like EnBW Energie Baden-Württemberg commonly do use debt without problems. Taking the abovementioned factors together we do think EnBW Energie Baden-Württemberg's debt poses some risks to the business. While that debt can boost returns, we think the company has enough leverage now. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. For instance, we've identified 4 warning signs for EnBW Energie Baden-Württemberg that you should be aware of.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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.