Energix - Renewable Energies (TLV:ENRG) Has A Somewhat Strained Balance Sheet

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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. As with many other companies Energix - Renewable Energies Ltd (TLV:ENRG) makes use of debt. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

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. 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, 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.

Check out our latest analysis for Energix - Renewable Energies

What Is Energix - Renewable Energies's Debt?

The image below, which you can click on for greater detail, shows that at September 2020 Energix - Renewable Energies had debt of ₪1.59b, up from ₪987.2m in one year. However, because it has a cash reserve of ₪1.03b, its net debt is less, at about ₪562.9m.

How Healthy Is Energix - Renewable Energies' Balance Sheet?

According to the last reported balance sheet, Energix - Renewable Energies had liabilities of ₪221.8m due within 12 months, and liabilities of ₪1.93b due beyond 12 months. Offsetting these obligations, it had cash of ₪1.03b as well as receivables valued at ₪73.9m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₪1.05b.

Since publicly traded Energix - Renewable Energies shares are worth a total of ₪6.14b, it seems unlikely that this level of liabilities would be a major threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse.

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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Energix - Renewable Energies has net debt to EBITDA of 3.1 suggesting it uses a fair bit of leverage to boost returns. But the high interest coverage of 9.5 suggests it can easily service that debt. Unfortunately, Energix - Renewable Energies saw its EBIT slide 5.5% in the last twelve months. If earnings continue on that decline then managing that debt will be difficult like delivering hot soup on a unicycle. There's no doubt that we learn most about debt from the balance sheet. But it is Energix - Renewable Energies's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. 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, Energix - Renewable Energies saw substantial negative free cash flow, in total. 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

Energix - Renewable Energies's struggle to convert EBIT to free cash flow had us second guessing its balance sheet strength, but the other data-points we considered were relatively redeeming. In particular, its interest cover was re-invigorating. Taking the abovementioned factors together we do think Energix - Renewable Energies's debt poses some risks to the business. So while that leverage does boost returns on equity, we wouldn't really want to see it increase from here. 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. These risks can be hard to spot. Every company has them, and we've spotted 3 warning signs for Energix - Renewable Energies (of which 2 make us uncomfortable!) you should know about.

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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