GEK TERNA Holdings Real Estate Construction (ATH:GEKTERNA) Seems To Be Using A Lot Of Debt

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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. We note that GEK TERNA Holdings, Real Estate, Construction S.A. (ATH:GEKTERNA) does have debt on its balance sheet. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, 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. 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 GEK TERNA Holdings Real Estate Construction

How Much Debt Does GEK TERNA Holdings Real Estate Construction Carry?

As you can see below, at the end of December 2020, GEK TERNA Holdings Real Estate Construction had €2.43b of debt, up from €2.02b a year ago. Click the image for more detail. On the flip side, it has €1.12b in cash leading to net debt of about €1.31b.

How Strong Is GEK TERNA Holdings Real Estate Construction's Balance Sheet?

According to the last reported balance sheet, GEK TERNA Holdings Real Estate Construction had liabilities of €801.6m due within 12 months, and liabilities of €3.01b due beyond 12 months. On the other hand, it had cash of €1.12b and €408.7m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by €2.29b.

This deficit casts a shadow over the €911.1m company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. After all, GEK TERNA Holdings Real Estate Construction would likely require a major re-capitalisation if it had to pay its creditors today.

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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

While we wouldn't worry about GEK TERNA Holdings Real Estate Construction's net debt to EBITDA ratio of 4.7, we think its super-low interest cover of 1.6 times is a sign of high leverage. It seems clear that the cost of borrowing money is negatively impacting returns for shareholders, of late. The good news is that GEK TERNA Holdings Real Estate Construction improved its EBIT by 9.3% over the last twelve months, thus gradually reducing its debt levels relative to its earnings. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine GEK TERNA Holdings Real Estate Construction'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 we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Looking at the most recent three years, GEK TERNA Holdings Real Estate Construction recorded free cash flow of 27% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Our View

To be frank both GEK TERNA Holdings Real Estate Construction's interest cover and its track record of staying on top of its total liabilities make us rather uncomfortable with its debt levels. But at least it's pretty decent at growing its EBIT; that's encouraging. Overall, it seems to us that GEK TERNA Holdings Real Estate Construction's balance sheet is really quite a risk to the business. For this reason we're pretty cautious about the stock, and we think shareholders should keep a close eye on its liquidity. 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. For example, we've discovered 3 warning signs for GEK TERNA Holdings Real Estate Construction (1 is a bit concerning!) that you should be aware of before investing here.

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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