These 4 Measures Indicate That Terna Energy Societe Anonyme Commercial Technical (ATH:TENERGY) Is Using Debt Reasonably Well

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. We note that Terna Energy Societe Anonyme Commercial Technical Company (ATH:TENERGY) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

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. 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 step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Terna Energy Societe Anonyme Commercial Technical

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

The image below, which you can click on for greater detail, shows that Terna Energy Societe Anonyme Commercial Technical had debt of €944.6m at the end of September 2020, a reduction from €1.01b over a year. However, it also had €324.2m in cash, and so its net debt is €620.4m.

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

We can see from the most recent balance sheet that Terna Energy Societe Anonyme Commercial Technical had liabilities of €44.6m falling due within a year, and liabilities of €1.45b due beyond that. On the other hand, it had cash of €324.2m and €1.40b worth of receivables due within a year. So it can boast €222.6m more liquid assets than total liabilities.

This surplus suggests that Terna Energy Societe Anonyme Commercial Technical has a conservative balance sheet, and could probably eliminate its debt without much difficulty.

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). 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).

While Terna Energy Societe Anonyme Commercial Technical's debt to EBITDA ratio (3.2) suggests that it uses some debt, its interest cover is very weak, at 1.6, suggesting high leverage. It seems clear that the cost of borrowing money is negatively impacting returns for shareholders, of late. Fortunately, Terna Energy Societe Anonyme Commercial Technical grew its EBIT by 4.3% in the last year, slowly shrinking its debt relative to earnings. 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 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, while the tax-man may adore accounting profits, lenders only accept 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 reported free cash flow worth 16% of its EBIT, which is really quite low. That limp level of cash conversion undermines its ability to manage and pay down debt.

Our View

Based on what we've seen Terna Energy Societe Anonyme Commercial Technical is not finding it easy, given its interest cover, but the other factors we considered give us cause to be optimistic. In particular, we thought its level of total liabilities was a positive. Looking at all this data makes us feel a little cautious about Terna Energy Societe Anonyme Commercial Technical's debt levels. While we appreciate debt can enhance returns on equity, we'd suggest that shareholders keep close watch on its debt levels, lest they increase. 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. To that end, you should learn about the 4 warning signs we've spotted with Terna Energy Societe Anonyme Commercial Technical (including 1 which is concerning) .

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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