Does GEK TERNA Holdings Real Estate Construction (ATH:GEKTERNA) Have A Healthy Balance Sheet?

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. As with many other companies GEK TERNA Holdings, Real Estate, Construction S.A. (ATH:GEKTERNA) makes use of debt. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. 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.

Check out our latest analysis for GEK TERNA Holdings Real Estate Construction

What Is GEK TERNA Holdings Real Estate Construction's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of June 2023 GEK TERNA Holdings Real Estate Construction had €3.01b of debt, an increase on €2.71b, over one year. However, because it has a cash reserve of €1.47b, its net debt is less, at about €1.54b.

A Look At GEK TERNA Holdings Real Estate Construction's Liabilities

Zooming in on the latest balance sheet data, we can see that GEK TERNA Holdings Real Estate Construction had liabilities of €1.41b due within 12 months and liabilities of €3.39b due beyond that. On the other hand, it had cash of €1.47b and €1.11b worth of receivables due within a year. So its liabilities total €2.22b more than the combination of its cash and short-term receivables.

This deficit casts a shadow over the €1.17b company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. At the end of the day, GEK TERNA Holdings Real Estate Construction would probably need a major re-capitalization if its creditors were to demand repayment.

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.

GEK TERNA Holdings Real Estate Construction has a debt to EBITDA ratio of 2.7 and its EBIT covered its interest expense 3.8 times. This suggests that while the debt levels are significant, we'd stop short of calling them problematic. Looking on the bright side, GEK TERNA Holdings Real Estate Construction boosted its EBIT by a silky 92% in the last year. Like a mother's loving embrace of a newborn that sort of growth builds resilience, putting the company in a stronger position to manage its debt. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if GEK TERNA Holdings Real Estate Construction 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Looking at the most recent three years, GEK TERNA Holdings Real Estate Construction recorded free cash flow of 28% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

Our View

We'd go so far as to say GEK TERNA Holdings Real Estate Construction's level of total liabilities was disappointing. But at least it's pretty decent at growing its EBIT; that's encouraging. Overall, we think it's fair to say that GEK TERNA Holdings Real Estate Construction has enough debt that there are some real risks around the balance sheet. If all goes well, that should boost returns, but on the flip side, the risk of permanent capital loss is elevated by the debt. 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. These risks can be hard to spot. Every company has them, and we've spotted 1 warning sign for GEK TERNA Holdings Real Estate Construction you should know about.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.