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

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. As with many other companies EnBW Energie Baden-Württemberg AG (ETR:EBK) makes use of debt. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

View 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 2023 EnBW Energie Baden-Württemberg had €14.8b of debt, an increase on €11.8b, over one year. However, it does have €6.44b in cash offsetting this, leading to net debt of about €8.35b.

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

According to the last reported balance sheet, EnBW Energie Baden-Württemberg had liabilities of €18.5b due within 12 months, and liabilities of €29.2b due beyond 12 months. Offsetting this, it had €6.44b in cash and €5.70b in receivables that were due within 12 months. So its liabilities total €35.6b more than the combination of its cash and short-term receivables.

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'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.

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). 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 has a low net debt to EBITDA ratio of only 1.2. And its EBIT covers its interest expense a whopping 34.3 times over. So we're pretty relaxed about its super-conservative use of debt. Better yet, EnBW Energie Baden-Württemberg grew its EBIT by 187% last year, which is an impressive improvement. That boost will make it even easier to pay down debt going forward. The balance sheet is clearly the area to focus on when you are analysing debt. 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 we always check how much of that EBIT is translated into free cash flow. In the last three years, EnBW Energie Baden-Württemberg's free cash flow amounted to 26% of its EBIT, less than we'd expect. That's not great, when it comes to paying 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 EBIT growth rate give us some confidence in its ability to manage its debt. 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. 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 3 warning signs for EnBW Energie Baden-Württemberg (of which 2 are a bit unpleasant!) you should know about.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.