Here's Why Adani Green Energy (NSE:ADANIGREEN) Has A Meaningful Debt Burden

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.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. As with many other companies Adani Green Energy Limited (NSE:ADANIGREEN) makes use of debt. But is this debt a concern to shareholders?

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. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Adani Green Energy

What Is Adani Green Energy's Debt?

The image below, which you can click on for greater detail, shows that at September 2021 Adani Green Energy had debt of ₹435.5b, up from ₹197.5b in one year. However, because it has a cash reserve of ₹36.7b, its net debt is less, at about ₹398.8b.

How Strong Is Adani Green Energy's Balance Sheet?

We can see from the most recent balance sheet that Adani Green Energy had liabilities of ₹103.7b falling due within a year, and liabilities of ₹384.0b due beyond that. On the other hand, it had cash of ₹36.7b and ₹13.8b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₹437.1b.

Of course, Adani Green Energy has a titanic market capitalization of ₹3.02t, so these liabilities are probably manageable. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse.

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.

Adani Green Energy shareholders face the double whammy of a high net debt to EBITDA ratio (13.5), and fairly weak interest coverage, since EBIT is just 1.7 times the interest expense. The debt burden here is substantial. Looking on the bright side, Adani Green Energy boosted its EBIT by a silky 44% in the last year. Like a mother's loving embrace of a newborn that sort of growth builds resilience, putting the company in a stronger position to manage its debt. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Adani Green Energy will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the last three years, Adani Green Energy 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

Adani Green 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 Adani Green 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. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For example Adani Green Energy has 2 warning signs (and 1 which doesn't sit too well with us) 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.

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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.