These 4 Measures Indicate That EnBW Energie Baden-Württemberg (ETR:EBK) Is Using Debt Extensively

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. We note that EnBW Energie Baden-Württemberg AG (ETR:EBK) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

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. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for EnBW Energie Baden-Württemberg

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

As you can see below, at the end of September 2020, EnBW Energie Baden-Württemberg had €9.14b of debt, up from €8.33b a year ago. Click the image for more detail. On the flip side, it has €1.99b in cash leading to net debt of about €7.15b.

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

The latest balance sheet data shows that EnBW Energie Baden-Württemberg had liabilities of €9.30b due within a year, and liabilities of €25.3b falling due after 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 outweigh the sum of its cash and (near-term) receivables by €29.4b.

The deficiency here weighs heavily on the €18.8b 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.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (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 debt to EBITDA ratio of 2.8 and its EBIT covered its interest expense 5.1 times. Taken together this implies that, while we wouldn't want to see debt levels rise, we think it can handle its current leverage. Notably, EnBW Energie Baden-Württemberg's EBIT launched higher than Elon Musk, gaining a whopping 223% on last year. 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.

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. Over the last three years, EnBW Energie Baden-Württemberg saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

To be frank both EnBW Energie Baden-Württemberg's level of total liabilities and its track record of converting EBIT to free cash flow make us rather uncomfortable with its debt levels. But at least it's pretty decent at growing its EBIT; that's encouraging. 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 all goes well, that should boost returns, but on the flip side, the risk of permanent capital loss is elevated by the debt. 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. To that end, you should learn about the 2 warning signs we've spotted with EnBW Energie Baden-Württemberg (including 1 which makes us a bit uncomfortable) .

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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