Is Endesa (BME:ELE) A Risky Investment?

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We note that Endesa, S.A. (BME:ELE) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Endesa

What Is Endesa's Net Debt?

You can click the graphic below for the historical numbers, but it shows that Endesa had €12.6b of debt in September 2024, down from €14.1b, one year before. However, because it has a cash reserve of €2.48b, its net debt is less, at about €10.1b.

A Look At Endesa's Liabilities

We can see from the most recent balance sheet that Endesa had liabilities of €11.8b falling due within a year, and liabilities of €18.9b due beyond that. Offsetting this, it had €2.48b in cash and €4.90b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by €23.3b.

Given this deficit is actually higher than the company's massive market capitalization of €22.9b, we think shareholders really should watch Endesa's debt levels, like a parent watching their child ride a bike for the first time. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer extensive dilution.

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).

Endesa's debt is 2.8 times its EBITDA, and its EBIT cover its interest expense 4.5 times over. This suggests that while the debt levels are significant, we'd stop short of calling them problematic. Shareholders should be aware that Endesa's EBIT was down 33% last year. If that earnings trend continues then paying off its debt will be about as easy as herding cats on to a roller coaster. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Endesa can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we always check how much of that EBIT is translated into free cash flow. Over the most recent three years, Endesa recorded free cash flow worth 56% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Our View

We'd go so far as to say Endesa's EBIT growth rate was disappointing. But on the bright side, its conversion of EBIT to free cash flow is a good sign, and makes us more optimistic. It's also worth noting that Endesa is in the Electric Utilities industry, which is often considered to be quite defensive. Overall, we think it's fair to say that Endesa has enough debt that there are some real risks around the balance sheet. If everything goes well that may pay off but the downside of this debt is a greater risk of permanent losses. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 3 warning signs for Endesa 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.