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

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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. Importantly, Terna Energy Societe Anonyme Commercial Technical Company (ATH:TENERGY) does carry debt. But should shareholders be worried about its use of debt?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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 Terna Energy Societe Anonyme Commercial Technical

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

As you can see below, Terna Energy Societe Anonyme Commercial Technical had €855.6m of debt at September 2021, down from €953.6m a year prior. However, because it has a cash reserve of €291.7m, its net debt is less, at about €563.9m.

How Strong 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 €59.7m due within 12 months and liabilities of €1.05b due beyond that. On the other hand, it had cash of €291.7m and €190.1m worth of receivables due within a year. So it has liabilities totalling €626.3m more than its cash and near-term receivables, combined.

Terna Energy Societe Anonyme Commercial Technical has a market capitalization of €1.58b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.

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 Terna Energy Societe Anonyme Commercial Technical's net debt to EBITDA ratio of 2.7, we think its super-low interest cover of 2.3 times is a sign of 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 7.3% in the last year, slowly shrinking its debt relative to earnings. There's no doubt that we learn most about debt from the balance sheet. 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 we always check how much of that EBIT is translated into free cash flow. In the last three years, Terna Energy Societe Anonyme Commercial Technical created free cash flow amounting to 14% of its EBIT, an uninspiring performance. That limp level of cash conversion undermines its ability to manage and pay down debt.

Our View

Both Terna Energy Societe Anonyme Commercial Technical's interest cover and its conversion of EBIT to free cash flow were discouraging. But its not so bad at growing its EBIT. When we consider all the factors discussed, it seems to us that Terna Energy Societe Anonyme Commercial Technical is taking some risks with its use of debt. So while that leverage does boost returns on equity, we wouldn't really want to see it increase from here. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. We've identified 1 warning sign with Terna Energy Societe Anonyme Commercial Technical , and understanding them should be part of your investment process.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.