The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says '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. Importantly, Grenergy Renovables, S.A. (BME:GRE) does carry debt. But the real question is whether this debt is making the company risky.
What Risk Does Debt Bring?
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. If things get really bad, the lenders can take control of the business. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.
See our latest analysis for Grenergy Renovables
What Is Grenergy Renovables's Debt?
The image below, which you can click on for greater detail, shows that at September 2020 Grenergy Renovables had debt of €134.4m, up from €72.5m in one year. However, because it has a cash reserve of €29.0m, its net debt is less, at about €105.5m.
How Healthy Is Grenergy Renovables' Balance Sheet?
The latest balance sheet data shows that Grenergy Renovables had liabilities of €37.4m due within a year, and liabilities of €140.8m falling due after that. Offsetting this, it had €29.0m in cash and €29.1m in receivables that were due within 12 months. So its liabilities total €120.2m more than the combination of its cash and short-term receivables.
Given Grenergy Renovables has a market capitalization of €843.4m, it's hard to believe these liabilities pose much threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time.
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). 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).
While Grenergy Renovables's debt to EBITDA ratio of 5.8 suggests a heavy debt load, its interest coverage of 8.1 implies it services that debt with ease. Our best guess is that the company does indeed have significant debt obligations. Importantly, Grenergy Renovables grew its EBIT by 63% over the last twelve months, and that growth will make it easier to handle its debt. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Grenergy Renovables can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.
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. During the last three years, Grenergy Renovables burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.
Our View
We weren't impressed with Grenergy Renovables's net debt to EBITDA, and its conversion of EBIT to free cash flow made us cautious. But its EBIT growth rate was significantly redeeming. Looking at all this data makes us feel a little cautious about Grenergy Renovables's debt levels. While we appreciate debt can enhance returns on equity, we'd suggest that shareholders keep close watch on its debt levels, lest they increase. 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. Case in point: We've spotted 3 warning signs for Grenergy Renovables you should be aware of, and 1 of them is potentially serious.
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.
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This article by Simply Wall St is general in nature. 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.
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About BME:GRE
High growth potential with proven track record.
