Is Naturgy Energy Group (BME:NTGY) Using Too Much Debt?

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. Importantly, Naturgy Energy Group, S.A. (BME:NTGY) does carry debt. But is this debt a concern to shareholders?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, 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.

View our latest analysis for Naturgy Energy Group

How Much Debt Does Naturgy Energy Group Carry?

As you can see below, at the end of December 2024, Naturgy Energy Group had €16.5b of debt, up from €14.5b a year ago. Click the image for more detail. However, it does have €5.69b in cash offsetting this, leading to net debt of about €10.8b.

How Strong Is Naturgy Energy Group's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Naturgy Energy Group had liabilities of €8.23b due within 12 months and liabilities of €21.0b due beyond that. Offsetting these obligations, it had cash of €5.69b as well as receivables valued at €3.65b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by €19.8b.

This is a mountain of leverage even relative to its gargantuan market capitalization of €24.1b. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry.

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.

Naturgy Energy Group's net debt of 2.2 times EBITDA suggests graceful use of debt. And the alluring interest cover (EBIT of 7.2 times interest expense) certainly does not do anything to dispel this impression. Sadly, Naturgy Energy Group's EBIT actually dropped 6.8% in the last year. If earnings continue on that decline then managing that debt will be difficult like delivering hot soup on a unicycle. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Naturgy Energy Group's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So it's worth checking how much of that EBIT is backed by free cash flow. Over the most recent three years, Naturgy Energy Group recorded free cash flow worth 63% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Our View

Even if we have reservations about how easily Naturgy Energy Group is capable of staying on top of its total liabilities, its conversion of EBIT to free cash flow and interest cover make us think feel relatively unconcerned. It's also worth noting that Naturgy Energy Group is in the Gas Utilities industry, which is often considered to be quite defensive. Looking at all the angles mentioned above, it does seem to us that Naturgy Energy Group 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. However, not all investment risk resides within the balance sheet - far from it. Be aware that Naturgy Energy Group is showing 3 warning signs in our investment analysis , and 1 of those makes us a bit uncomfortable...

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.