Terna Energy Societe Anonyme Commercial Technical (ATH:TENERGY) Has A Somewhat Strained Balance Sheet

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We note that Terna Energy Societe Anonyme Commercial Technical Company (ATH:TENERGY) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

Our analysis indicates that TENERGY is potentially overvalued!

How Much Debt Does Terna Energy Societe Anonyme Commercial Technical Carry?

You can click the graphic below for the historical numbers, but it shows that as of June 2022 Terna Energy Societe Anonyme Commercial Technical had €1.08b of debt, an increase on €810.0m, over one year. However, because it has a cash reserve of €401.2m, its net debt is less, at about €675.5m.

A Look At Terna Energy Societe Anonyme Commercial Technical's Liabilities

According to the last reported balance sheet, Terna Energy Societe Anonyme Commercial Technical had liabilities of €378.4m due within 12 months, and liabilities of €1.14b due beyond 12 months. On the other hand, it had cash of €401.2m and €107.0m worth of receivables due within a year. So it has liabilities totalling €1.01b more than its cash and near-term receivables, combined.

This deficit isn't so bad because Terna Energy Societe Anonyme Commercial Technical is worth €2.13b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt.

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.

Terna Energy Societe Anonyme Commercial Technical's debt is 3.8 times its EBITDA, and its EBIT cover its interest expense 4.9 times over. This suggests that while the debt levels are significant, we'd stop short of calling them problematic. It is well worth noting that Terna Energy Societe Anonyme Commercial Technical's EBIT shot up like bamboo after rain, gaining 46% in the last twelve months. That'll make it easier to manage its debt. There's no doubt that we learn most about debt from the balance sheet. 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.

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. Over the last three years, Terna Energy Societe Anonyme Commercial Technical recorded negative free cash flow, in total. Debt is usually more expensive, and almost always more risky in the hands of a company with negative free cash flow. Shareholders ought to hope for an improvement.

Our View

Terna Energy Societe Anonyme Commercial Technical's conversion of EBIT to free cash flow and net debt to EBITDA definitely weigh on it, in our esteem. But its EBIT growth rate tells a very different story, and suggests some resilience. 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. That's not necessarily a bad thing, since leverage can boost returns on equity, but it is something to be aware of. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. For example, we've discovered 2 warning signs for Terna Energy Societe Anonyme Commercial Technical 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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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.