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

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 should shareholders be worried about its use of debt?

When Is Debt A Problem?

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. If things get really bad, the lenders can take control of the business. 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, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Terna Energy Societe Anonyme Commercial Technical

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

You can click the graphic below for the historical numbers, but it shows that Terna Energy Societe Anonyme Commercial Technical had €810.0m of debt in June 2021, down from €1.10b, one year before. However, because it has a cash reserve of €315.0m, its net debt is less, at about €495.1m.

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 €177.1m due within 12 months, and liabilities of €881.3m due beyond 12 months. On the other hand, it had cash of €315.0m and €65.1m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by €678.4m.

While this might seem like a lot, it is not so bad since Terna Energy Societe Anonyme Commercial Technical has a market capitalization of €1.37b, and so it could probably strengthen its balance sheet by raising capital if it needed to. However, it is still worthwhile taking a close look at its ability to pay off debt.

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.

Even though Terna Energy Societe Anonyme Commercial Technical's debt is only 2.5, its interest cover is really very low at 2.2. This does have us wondering if the company pays high interest because it is considered risky. In any case, it's safe to say the company has meaningful debt. One way Terna Energy Societe Anonyme Commercial Technical could vanquish its debt would be if it stops borrowing more but continues to grow EBIT at around 14%, as it did over the last year. 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 Terna Energy Societe Anonyme Commercial Technical'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 it's worth checking how much of that EBIT is backed by free cash flow. In the last three years, Terna Energy Societe Anonyme Commercial Technical created free cash flow amounting to 5.6% of its EBIT, an uninspiring performance. That limp level of cash conversion undermines its ability to manage and pay down debt.

Our View

While Terna Energy Societe Anonyme Commercial Technical's conversion of EBIT to free cash flow makes us cautious about it, its track record of covering its interest expense with its EBIT is no better. At least its EBIT growth rate gives us reason to be optimistic. Taking the abovementioned factors together we do think Terna Energy Societe Anonyme Commercial Technical's debt poses some risks to the business. While that debt can boost returns, we think the company has enough leverage now. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. For example Terna Energy Societe Anonyme Commercial Technical has 3 warning signs (and 1 which shouldn't be ignored) we think you should know about.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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.

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