These 4 Measures Indicate That Enlight Renewable Energy (TLV:ENLT) Is Using Debt Extensively

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We can see that Enlight Renewable Energy Ltd (TLV:ENLT) does use debt in its business. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Enlight Renewable Energy

What Is Enlight Renewable Energy's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2020 Enlight Renewable Energy had ₪3.67b of debt, an increase on ₪2.58b, over one year. On the flip side, it has ₪1.03b in cash leading to net debt of about ₪2.64b.

A Look At Enlight Renewable Energy's Liabilities

We can see from the most recent balance sheet that Enlight Renewable Energy had liabilities of ₪484.8m falling due within a year, and liabilities of ₪3.67b due beyond that. Offsetting this, it had ₪1.03b in cash and ₪217.3m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₪2.90b.

While this might seem like a lot, it is not so bad since Enlight Renewable Energy has a market capitalization of ₪5.42b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.

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 Enlight Renewable Energy's debt to EBITDA ratio of 16.2 suggests a heavy debt load, its interest coverage of 8.7 implies it services that debt with ease. Overall we'd say it seems likely the company is carrying a fairly heavy swag of debt. Notably, Enlight Renewable Energy's EBIT launched higher than Elon Musk, gaining a whopping 125% on last year. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Enlight Renewable Energy's ability to maintain a healthy balance sheet going forward. 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 it's worth checking how much of that EBIT is backed by free cash flow. During the last three years, Enlight Renewable Energy burned a lot of cash. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Our View

Enlight Renewable Energy's conversion of EBIT to free cash flow and net debt to EBITDA definitely weigh on it, in our esteem. But the good news is it seems to be able to grow its EBIT with ease. When we consider all the factors discussed, it seems to us that Enlight Renewable Energy 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. To that end, you should learn about the 4 warning signs we've spotted with Enlight Renewable Energy (including 3 which don't sit too well with us) .

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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