Is ACEA (BIT:ACE) Using Too Much Debt?

Warren Buffett famously said, '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. We can see that ACEA S.p.A. (BIT:ACE) does use debt in its business. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for ACEA

What Is ACEA's Debt?

You can click the graphic below for the historical numbers, but it shows that as of December 2021 ACEA had €5.02b of debt, an increase on €4.50b, over one year. However, it also had €683.1m in cash, and so its net debt is €4.34b.

A Look At ACEA's Liabilities

According to the last reported balance sheet, ACEA had liabilities of €2.60b due within 12 months, and liabilities of €5.51b due beyond 12 months. On the other hand, it had cash of €683.1m and €1.80b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by €5.63b.

This deficit casts a shadow over the €3.48b company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. At the end of the day, ACEA would probably need a major re-capitalization if its creditors were to demand repayment.

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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

With net debt to EBITDA of 4.2 ACEA has a fairly noticeable amount of debt. But the high interest coverage of 7.3 suggests it can easily service that debt. One way ACEA could vanquish its debt would be if it stops borrowing more but continues to grow EBIT at around 19%, as it did over the last year. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if ACEA can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So it's worth checking how much of that EBIT is backed by free cash flow. Over the last three years, ACEA saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

On the face of it, ACEA's conversion of EBIT to free cash flow left us tentative about the stock, and its level of total liabilities was no more enticing than the one empty restaurant on the busiest night of the year. But at least it's pretty decent at growing its EBIT; that's encouraging. We should also note that Integrated Utilities industry companies like ACEA commonly do use debt without problems. Overall, it seems to us that ACEA's balance sheet is really quite a risk to the business. So we're almost as wary of this stock as a hungry kitten is about falling into its owner's fish pond: once bitten, twice shy, as they say. 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. Case in point: We've spotted 2 warning signs for ACEA you should be aware of, and 1 of them shouldn't be ignored.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.