Is Terna Energy Societe Anonyme Commercial Technical (ATH:TENERGY) A Risky Investment?

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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. Importantly, Terna Energy Societe Anonyme Commercial Technical Company (ATH:TENERGY) does carry debt. But the more important question is: how much risk is that debt creating?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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.

See our latest analysis for Terna Energy Societe Anonyme Commercial Technical

What Is Terna Energy Societe Anonyme Commercial Technical's Debt?

The chart below, which you can click on for greater detail, shows that Terna Energy Societe Anonyme Commercial Technical had €983.5m in debt in December 2021; about the same as the year before. However, it also had €399.2m in cash, and so its net debt is €584.4m.

How Healthy Is Terna Energy Societe Anonyme Commercial Technical's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Terna Energy Societe Anonyme Commercial Technical had liabilities of €301.9m due within 12 months and liabilities of €1.04b due beyond that. Offsetting these obligations, it had cash of €399.2m as well as receivables valued at €87.0m due within 12 months. So it has liabilities totalling €852.1m more than its cash and near-term receivables, combined.

This deficit isn't so bad because Terna Energy Societe Anonyme Commercial Technical is worth €1.91b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution.

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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Terna Energy Societe Anonyme Commercial Technical has a debt to EBITDA ratio of 3.5 and its EBIT covered its interest expense 5.5 times. This suggests that while the debt levels are significant, we'd stop short of calling them problematic. Also relevant is that Terna Energy Societe Anonyme Commercial Technical has grown its EBIT by a very respectable 29% in the last year, thus enhancing its ability to pay down 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 Terna Energy Societe Anonyme Commercial Technical 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.

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. In the last three years, Terna Energy Societe Anonyme Commercial Technical created free cash flow amounting to 4.2% of its EBIT, an uninspiring performance. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.

Our View

Neither Terna Energy Societe Anonyme Commercial Technical's ability to convert EBIT to free cash flow nor its net debt to EBITDA gave us confidence in its ability to take on more debt. But the good news is it seems to be able to grow its EBIT with ease. Looking at all the angles mentioned above, it does seem to us that Terna Energy Societe Anonyme Commercial Technical 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. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 1 warning sign for Terna Energy Societe Anonyme Commercial Technical that you should be aware of before investing here.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.