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 real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own 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. When we examine debt levels, we first consider both cash and debt levels, together.

See 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 2021 EnBW Energie Baden-Württemberg had €10.8b of debt, an increase on €9.25b, over one year. However, because it has a cash reserve of €4.61b, its net debt is less, at about €6.21b.

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

According to the last reported balance sheet, EnBW Energie Baden-Württemberg had liabilities of €26.8b due within 12 months, and liabilities of €29.1b due beyond 12 months. On the other hand, it had cash of €4.61b and €3.56b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by €47.8b.

This deficit casts a shadow over the €20.7b company, like a colossus towering over mere mortals. 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 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). 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 2.7, which signals significant debt, but is still pretty reasonable for most types of business. But its EBIT was about 1k times its interest expense, implying the company isn't really paying a high cost to maintain that level of debt. Even were the low cost to prove unsustainable, that is a good sign. The bad news is that EnBW Energie Baden-Württemberg saw its EBIT decline by 15% over the last year. If earnings continue to decline at that rate then handling the debt will be more difficult than taking three children under 5 to a fancy pants restaurant. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since EnBW Energie Baden-Württemberg will need earnings to service that debt. 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Looking at the most recent three years, EnBW Energie Baden-Württemberg recorded free cash flow of 22% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

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. We should also note that Electric Utilities industry companies like EnBW Energie Baden-Württemberg commonly do use debt without problems. We're quite clear that we consider EnBW Energie Baden-Württemberg to be really rather risky, as a result of its balance sheet health. For this reason we're pretty cautious about the stock, and we think shareholders should keep a close eye on its liquidity. 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. Case in point: We've spotted 4 warning signs for EnBW Energie Baden-Württemberg you should be aware of.

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.