SSE (LON:SSE) Has A Pretty Healthy Balance Sheet

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. We can see that SSE plc (LON:SSE) does use debt in its business. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

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. If things get really bad, the lenders can take control of the business. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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 SSE

What Is SSE's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2024 SSE had UK£9.18b of debt, an increase on UK£8.56b, over one year. On the flip side, it has UK£890.8m in cash leading to net debt of about UK£8.29b.

How Healthy Is SSE's Balance Sheet?

According to the last reported balance sheet, SSE had liabilities of UK£5.08b due within 12 months, and liabilities of UK£11.4b due beyond 12 months. On the other hand, it had cash of UK£890.8m and UK£2.69b worth of receivables due within a year. So it has liabilities totalling UK£12.9b more than its cash and near-term receivables, combined.

This deficit is considerable relative to its very significant market capitalization of UK£17.2b, so it does suggest shareholders should keep an eye on SSE's use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe 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).

SSE's net debt to EBITDA ratio of about 2.2 suggests only moderate use of debt. And its commanding EBIT of 24.3 times its interest expense, implies the debt load is as light as a peacock feather. Notably, SSE's EBIT launched higher than Elon Musk, gaining a whopping 134% on last year. 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 SSE's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

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. Over the last three years, SSE reported free cash flow worth 17% of its EBIT, which is really quite low. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.

Our View

SSE's interest cover was a real positive on this analysis, as was its EBIT growth rate. On the other hand, its conversion of EBIT to free cash flow makes us a little less comfortable about its debt. It's also worth noting that SSE is in the Electric Utilities industry, which is often considered to be quite defensive. When we consider all the elements mentioned above, it seems to us that SSE is managing its debt quite well. Having said that, the load is sufficiently heavy that we would recommend any shareholders keep a close eye on it. 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 2 warning signs for SSE you should be aware of.

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.